Optimists about inflation wager that falling housing prices will have a deflationary effect on the economy. They seem to have some mathematics on their side, but their hypothesis of the reasons why inflation increases or decreases is flawed. The falling costs of homes and rentals won’t make much of a difference in our inflation issue.
An outstanding economist by the name of Alan Reynolds describes one possible reason for the relationship between housing and inflation. He notes that the consumer price index, excluding housing costs, has remained relatively stable over the last half year.He also emphasizes that the shelter component of the CPI generally lags behind visible price changes, such as drops in house values recorded by the Federal Housing Finance Administration and changes in rental rates reported by Zillow and ApartmentList. Specifically, he cites examples of both. The method by which housing expenses are accounted for in the CPI is not obvious. (An excellent explanation may be found at the Brookings Institution.)
The error here is to believe that inflation equals the aggregate of all of the price shifts that have occurred in the economy. as though the rate of inflation would decrease whenever any significant factor began to decline. The idea that inflation is caused by excessive stimulation of the economy beyond our ability to provide it is the one that is more correct. Price fluctuations at the individual level are only the outward expression of excessive collective stimulation. Even if one price level stabilizes, the surplus demand will manifest itself at another.
Do you recall the significant increase in the cost of used automobiles that occurred back in the summer of 2020? In those days, Reuters stated that “a 5.4% leap in prices of used vehicles and trucks, the greatest increase since March 1969, accounted for more than 40% of the rise in the so-called core CPI last month.” This was the highest gain since March 1969. Because of this, some economists came to the conclusion that secondhand automobiles were to blame for the rise in inflation. In fact, individuals got rewards as a kind of incentive quite early on in the epidemic. They were unable to go somewhere or eat at a restaurant. A good number of them made the decision to improve their vehicles. However, the supply of secondhand automobiles is quite stable since it takes around three years to manufacture a vehicle that is three years old. Therefore, the demand that was generated by the stimulus drove up the price of used automobiles. After some time had passed, individuals eventually gave up the search for an excellent used automobile at a price that was within their budget and spent their money elsewhere. At that time, inflation began to spread more broadly.
The checks from the government were just part of the story. One other component of the overall stimulus was the reduction in interest rates and increased purchasing of financial assets by the Federal Reserve. People purchased single-family houses or made attempts to purchase them. And an even larger number of consumers were able to refinance their mortgages at much reduced interest rates, freeing up more funds for them to spend. Because of this, property prices rose.
People who were not considering purchasing a home had extra money available to them as a result of stimulus checks and wage rises. These people were not considering purchasing a home. Many made the decision to live on their own. They have either left the basement of their parents’ house, expelled a roommate, or divorced their spouse and are living on their own. The rise in apartment rentals may be attributed to the rising demand for housing. As a result, stimulus caused an increase in the housing subcomponent of the CPI.
In the most recent months, both the prices of homes and the rentals of apartments have begun to fall. At the present pricing and mortgage rates, a lot of individuals have come to the conclusion that it doesn’t make any sense to purchase a property. Others have examined their finances and concluded that, due to the high cost of rent and the high cost of almost everything else, having a roommate is not such a terrible idea after all.
It is not the property market in particular that will drive inflation down; rather, it is the general decrease in stimulus that will do it. The impact of the fiscal policy aspect of the stimulus is leveling off but remains rather significant. The monetary policy is becoming more restrictive. These measures will have the effect of lowering inflation. However, price variations are simply where the consequences will become apparent to us. The decrease in inflation will not be the cause of price declines in housing or used vehicles; rather, these price changes are just the manifestation of the reduced inflation.