Inflation: house prices will have an impact on the duration of the problem

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A real estate sign in Vienna, Virginia in 2014. (Larry Downing / Reuters)

The extent to which inflation is “transient” may depend on whether recent housing price spikes translate into increases in rents and housing services.

Ja experienced the third consecutive monthly rise in inflation, with an annual rate of 5.4% and core inflation (excluding gas and energy prices) reaching 4.5%. the core inflation month-to-month interest rates make the picture of accelerating inflation even bleaker, as month-to-month measurements have been operating at a rate never seen since the early 1980s.

Economic policymakers explained the data by pointing to short-term pandemic-related phenomena such as higher prices for trucks and used cars (which account for about a third of the increase) or “base effects” , that is to say, inflation is rebounding after falling to a low level in March 2020. In short, the argument continues to be advanced, but with a little more hesitation than before, than this news rise in inflation is “transient”. Adding some force to this case, other measures of inflation such as the “truncated average” and “median” inflation rates published by the Federal Reserve Bank of Cleveland, which removes outliers such as used cars and trucks, show much lower inflation rates (Year-over-year rates of 2.90% and 2.21%, respectively).

While it is likely that used car prices and other distortions related to the pandemic will subside before too long, price pressure in another sector of the economy could have a significant impact on the economy. inflation in the future, namely housing. In recent months, we have seen huge increases in house prices almost in the range of 15% year over year, based on the Case-Shiller Home Price Index.

However, due to the way housing is integrated with inflation measures, these increases have not yet significantly marked the inflation data. The house prices themselves are not included in inflation. Instead, the Consumer Price Index (CPI) measures the housing cost, which is divided into two components, the actual rents and what is known as the owners’ principal residence equivalent rent (REL). The REL is determined by determining the amount of rent that can be charged for a home occupied by its owner. “Shelter” represents as much as 33 percent of the CPI basket released by the Bureau of Labor Statistics.

Why hasn’t it appeared in the inflation data yet? History suggests there is a lag between house prices and rent increases of about five quarters (ie rents are “sticky”). An increase in rent prices of just a few percentage points could indicate sustained inflation in the future and change the discourse on “transient” inflation. Prediction markets now estimate a 61% probability of month-over-month inflation exceeded 0.6% in July. Housing provides a good example of how monetary policy affects the “real” economy. A rise in interest rates too early could dampen mortgage borrowing and dampen the real estate markets, potentially causing a real estate crash, with all the damage that can result (as we saw in 2008). Many accuse the Federal Reserve of raising the federal funds rate in 2006 as one of the contributing factors to the global financial crisis. They argue that high interest rates deterred buying a home (since higher mortgage rates make buying a home more difficult), which then led to a bigger crash. Unfortunately, it is the poor who suffer when the housing market collapses. As economists Amir Sufi and Atif Mian show in their classic book Debt house, people in the lowest income quintiles suffered the most damage to their net worth during the Great Recession, as they tend to borrow the most mortgage debt (as a fraction of their income) and disproportionate amount of their wealth is concentrated in housing compared to the rich.

It is also important to remember that inflation also disproportionately hurts the poor. Goods and services purchased by people in lower income quintiles experience higher inflation rates, economist says Xavier Jaravel showed. In addition to this, the poor spend more of their income on consumption, which means that the purchasing power of their total income declines much faster, especially when real wages turn negative as they are now.

The timeframe within which the Fed will reduce the monetary accommodation and raise interest rates largely depends on how inflation evolves. It is possible that inflation will fall back on its own towards the Fed’s long-term inflation target of 2% after the supply shortages caused by the pandemic disappear. (It should be noted that in August 2020, the Fed adopted a “flexible average inflation target,” which means that instead of targeting 2% inflation at any time, it can deviate from this target. target for a period of time up to 2%. Average inflation is reached over an indefinite period of time.)

However, even if these transient effects fade, it is possible that rising house prices will keep inflation up and contribute to a durably higher inflation rate. The longer inflation stays high, the more likely it is that inflation expectations will become ‘unanchored’ (that is, individuals on the margin no longer believe that the Fed is committed to its target. inflation), leading to self-sustaining inflation at a rate well above where the Fed would like it to be.

If this turns out to be the case, the Fed will realize at some point the need to fight inflation, start cutting back on asset purchases, and signal less accommodative interest policy in its forecast. . Fed Chairman Jay Powell has suggested he is embarking on this data-dependent approach (balancing inflation concerns with full employment as required by the Fed’s dual tenure) and will continue. likely this route, assuming he is able to secure another nomination as president (betting markets at the time of this writing predict that Powell has about 80% chance of being reappointed by President Biden).

Either way, we’ll get back to target inflation; one path simply requires a very different political regime (eg, ending asset purchases faster and raising rates sooner). And this trajectory will depend greatly on the evolution of other inflation dynamics, in particular housing. Even the New York Times agrees, citing the cost of housing as something to watch out for.

The Gray Lady is not always wrong.

Jon Hartley has a doctorate in economics. student at Stanford University and visiting scholar at the Equal Opportunities Research Foundation. He previously served as Senior Policy Advisor to the Congress Joint Economic Committee.



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