Video: Housing Demand Unaffected by Mortgage Deduction Repeal?

There may be rumblings about lowering the cap on mortgage interest rate deductions, but it would have a "rather small effect" on the housing market, Nobel Prize-winning economist Robert Shiller told CNBC on Wednesday.

The popular deduction is "limited to a small percent of taxpayers. It's just not that big an effect compared to the big things," the Yale economics professor said in an interview with "Power Lunch."

"What's really driving the real estate market is our sense of where we're going and the uncertainty at the time with the new administration in Washington and all this talk."

For example, things like the deadly white supremacist rally in Charlottesville, Virginia, slows down people's willingness to make a big financial transaction, noted Shiller, who co-founded the Case-Shiller index.

The mortgage interest deduction enables homeowners to deduct the interest paid on their home loans from their income taxes. It is currently capped at loans up to $1 million for married couples filing jointly. The cap is $500,000 for those filing separately.

Industry sources have told CNBC that reducing the deduction is on the negotiating table as Republicans work to hammer out a tax reform package.

However, most homeowners don't claim the deduction and instead use the standard deduction, Shiller said.

Therefore, he believes lowering the cap would have more of a psychological effect on home prices than a calculated one.

"This is part of American culture. It goes back to the American dream," he said. "It stands for something. It stands for 'the government is behind the homeowner.' It's a political thing."

On Tuesday, Toll Brothers CEO Doug Yearley told CNBC that changing the deduction would be "very bad policy" and would discourage homeownership.