The Fed Is Trying to Force Down Housing Prices

How much inflation is really a housing cost problem?

Last year the increase in inflation could be explained by the price of vehicles. During this year it can be explained mainly with energy prices.

But, the prices of cars and other goods have already stabilized, plus energy prices are falling. The ones that are going up fast are the rental prices, which are going up fast. Housing costs accounted for two-thirds of inflation in the last quarter, exceeding the Federal Reserve’s 2% target.

Since most Americans don’t rent their homes, the main way rents enter into inflation statistics is through owners’ equivalized rent — the government estimates how much owner-occupied homes would rent. The big cost homeowners pay their mortgage debt service, which the Federal Reserve is currently boosting.

Zillow said market rents rose more than 10% last year. While homeownership rates have recovered somewhat, they are still well below what they were in the mid-2000s. And with vacancy rates for both rental and owner-occupied housing at their lowest in 40 years, the housing shortage is likely to worsen.

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Most goods in the economy are linked to a specific long-term asset. Housing is different. The supply of haircuts or child care depends on how many resources of society we can devote to producing them today. Unlike the housing supply, it depends on the amount we have built in the past.

This means that conventional monetary policy is inadequate to deal with rising house prices. Because the housing stock adjusts slowly, housing costs can increase even when the economy is sluggish. And because housing production relies on credit, that’s where higher interest rates have their biggest effects. Housing starts are already down 20% since the start of this year. This will have only a modest impact on current demand but a large effect on housing supply for years to come. Economics 101 should tell you that if efforts to reduce demand also reduce supply, prices won’t go down much. They might even go up.

What should we do instead?

We have to take into account the limitations of the construction of new housing. In metropolitan areas, the value of homes can be twice the construction cost. When this happens, we take advantage of it more. So if the property’s value comes from the land where it was built, it is a sign that the construction is below demand. The problem we need to solve is not that people pay so much to live in New York, Los Angeles, Boston, or Boulder, Colo. It is very difficult to add housing there.

We cannot change land use rules overnight; thousands of jurisdictions set them. But some steps can be taken now. For example, the federal government could tie funding to transportation to allow for higher-density development near transit.

We need more public investment. Government support through subsidies or direct ownership is essential for affordable housing. But the government’s role does not have to be limited to the low-income segment. With its long-term horizons, the public sector has great advantages in building and financing housing for the middle class.

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Looking around the world, we find examples of how governments can successfully take on the role of developing housing. In Singapore, where it is very difficult to be Hostile to private enterprises, the public Housing Development Board builds most of the new housing. In Vienna, much of the housing in the city is still provided by buildings built by the government between the world wars. Before privatizations under Prime Minister Margaret Thatcher, around 30% of English families lived in publicly owned housing.

In the US, public housing has fallen out of favor. But governments at all levels continue to support affordable housing construction through subsidies and incentives. Some public developers, like the Housing Production Fund of Montgomery County, Maryland, find that they can compete with private developers for mixed-income housing with cheap financing and no need to generate returns for investors. The important thing is to channel new public money to development instead of vouchers for tenants. The latter may increase the price of the existing home.

Third, we must review the rent regulation. The argument against rent control is supposed to be that it discourages new construction. But empirical studies have repeatedly failed to find such an effect. This should not be surprising. The high-income areas where controls are adopted are precisely those where the construction of new homes is already heavily restricted. If not much is built, rent regulation simply prevents existing homeowners from claiming windfall profits from rising demand.

No, rent control will not boost the housing supply. But you can limit the price increase until a new offer is online. And it’s a much better-targeted response to rising housing costs than the policy-induced recession we’re currently heading into.