A Comment on Housing, Inflation, and Fed Policy
A comment on housing, inflation, and Fed policy (and a side comment on spending)
No big economic news today, and as usual little State reporting on COVID over the weekend, so let me make a couple of points.
As an initial note, the big report I will be paying attention to this week is personal spending and income, which will be reported on Thursday.
As I’ve noted several times recently, the goods-producing side of the economy has been fading somewhat. And earlier this month, we got an awful retail sales report (which we average about once every year).
Personal spending is the flip side of retail sales. And what’s been happening there is a bifurcation between spending on goods vs. spending on services. Here’s a graph of each, normed to 100 as of right before the pandemic:
There was a huge increase in spending on goods, especially in last spring’s stimulus spending spree. But that was while a lot of people were avoiding social events and were ordering stuff from home. While that has faded in the past year, spending on services has motored right ahead, and is presently still up about 6% YoY – which in the long term is a *very* healthy rate.
Which means that the signal from a fading goods-producing sector – normally a reliable leading indicator – may be overstated this time around.
We’ll get a further read on that Thursday.
Now, on to my main topic: inflation.
Prof. Paul Krugman continues to tweet that inflation may be taking care of itself, and the Fed shouldn’t hit the brakes too hard, e.g., in this long twitter thread:
https://mobile.twitter.com/paulkrugman/status/1541039031525457923
I would be very cautious about this. That’s because, to recapitulate, 1/3rd of the entire CPI reading is housing, and housing prices have been on a tear. That gets reflected, with a 12 to 18 month lag, in “owner’s equivalent rent” (OER), which is currently at a 30 year high (gold in the graph below, vs. overall CPI, red):
Inflation normally declines before OER peaks, but precisely *because* the Fed slams on the brakes (black in the graph above).
Well, house prices are still up (awaiting tomorrow’s updates) about 16% YoY. That is going to continue to feed into OER for the next 12 months at least.
In other words, the only reason inflation declines in the next 12 months is if the non-housing 2/3’s of the number slows down drastically. I’m skeptical of that happening if the Fed retreats towards the sidelines.
That being said, the Fed should as a matter of discipline differentiate between supply-driven inflation, especially of durable goods, vs. demand-driven inflation. That’s because, if there is a supply bottleneck, that bottleneck isn’t going to magically disappear by cutting down demand. All it is going to do is create more pent-up demand, and unleash more inflation in that good once interest rates are lowered.
This is particularly true of housing. To the extent housing inflation is driven by a shortage of construction materials, building even less housing to keep a lid on prices just means even more of a shortage of housing, and more demand once the Fed releases the brakes. In other words, if there’s a shortage of supply of a durable good, the Fed ought to accept higher inflation rather than bring on a needless recession which won’t cure that shortage anyway.
The situation you have described involves both general inflation and relative price change. Here’s the relative price change part:
“In other words, the only reason inflation declines in the next 12 months is if the non-housing 2/3’s of the number slows down drastically.”
There is a simple bit of economic logic behind the Fed’s focus on general rather than relative price change; holding general price rise to 2% per year when 1/3 of the price index is rising at 16% means imposing a large price decline on the rest of the consumption basket.
Housing is among the more rate-sensitive secctor of the economy. Housing price gains will eventually abate with higher rates. Driving down inflation while housing prices are still rising rapidly is recessionary. Having some patience while higher rates work to cool housing price gains is not necessarily recessionary, though there is still a risk of recession.
should as a matter of discipline differentiate between supply-driven inflation, especially of durable goods, vs. demand-driven inflation.
“
Believe it!
Here is how works :
Demand-driven is always infinite.
Demand from folks with money is finite but expansible by fed governors who print FRN, federal reserve notes for buying up treasury bonds from Congress. As Congress buys FRN with the bonds they have printed up they spend the FRN on their cronies who use the FRN to buy votes for the incumbent, flood the M2V with liquidity. Liquidity flood bids up home prices enough to keep poor people out of their neighborhood.
supply-driven is finite. Supply of real property on this planet is finite. Always be the same number of acres, same number of square kilometers. Same stack of gold bars on the planet.
As global population expands exponentially, real property per capita shrinks, price for homes expands exponentially. Folks die early from overcrowding. Dictators scramble to rob acres of land from their neighbors, kill people!
When you look further up the pipe you see the answer to the problem == excessive human fertility. The solution?
Universal
praepubertal
vasectomy
!