The threat to core inflation has for some time been that the unwinding of
the housing bubble could drag down the price of a substitute: rents. And, as
one would expect, just as the bubble in housing helped pull rental inflation
higher, the bust has helped to pull it lower (see Chart, source Bloomberg)
and the lagged effect of the bust will likely continue to drag it lower for
a time. But there are some signs that the bust in home prices may have nearly
run its natural course, and that the unnatural Fed actions are therefore no
longer necessary and perhaps dangerous.
For one thing, home prices are, roughly, back to being in-line with the long-run
trend in rents, as the next chart (Source: Bloomberg) shows. Why does that
matter? Recall that it is Owners' Equivalent Rent, and not home prices, that
appear in CPI. Any deviation in the growth in home prices above or below the
trend in rents - which measures what "the house as a place to live" is worth
- essentially reflects the residual investment value of the house. But...and
this is key!...since there's no reason to expect the investment value of
the house, in the long run, to reflect anything more than the value of living
in the house, these series ought to be very tightly related. And you can
see that they were, prior to the late 1990s.
Now, inventory of unsold homes is still high, but if we have reached the 'market
clearing price,' the inventory (as well as the 'shadow' inventory of homes
people want to sell but haven't bothered to list because of market conditions)
will eventually return to normal (see Chart, source Bloomberg). If prices drop below that
market clearing price, then this will happen somewhat more quickly.
Now, the increase in median home sale prices (which also showed up in other
data than the National Association of Realtors data, about which it is fair
to be suspicious) is largely seasonal: home prices always rise in the summer.
But even accounting for the normal seasonal pattern, it looks like home prices
rose. The signs of life are very tentative, especially because the data are
so noisy, but if home prices are finally back to the neighborhood of "fair
value" then those signs of life are not entirely unexpected and we should be
careful about cavalierly dismissing them.
The worry from an inflation standpoint is this: if there is some bottoming
in home prices, it was clearly completely independent of the Fed's monetary
stimulus. Prices are starting to bottom simply because they fell far enough.
We ought, therefore, to be concerned about the answer to the following question:
"Then what other prices are being pushed up by the fiscal and monetary
stimulus?"
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