Tuesday, April 28, 2015

Rising home prices are contributing to inflation

The housing market recovery continues, and the ongoing rise in home prices is going to be adding to official inflation statistics over the next year or two.

As the chart above shows, nationwide housing prices are only about 8% below their 2006-2007 highs, and prices are up 4-5% over the past year. It won't be long before housing prices reach new nominal highs.

Housing prices feed into the CPI via "Owner's Equivalent Rent," which is the BLS's estimate of how much homeowners would be paying to rent the house they own. Rents don't always track home prices, of course, but over time there is a strong tendency for rents to track prices. As the chart above shows, prices have outpaced rents since 1987 by about 30%. With prices rising 4-5% a year, it's a good bet that rents are going to keep rising, and probably at a faster pace than we've seen in recent years. 

As the chart above shows, rents have been rising a little more than 2.5% per year. The chart also suggests that, given the increase in home prices to date, rents are likely to rise by at least 3% in the next year or so. The chart further suggests that there is a lag of about 18 months between home prices and rents, with prices leading rents. Since OER constitutes about 25% of the CPI, this is going to be an important source of rising inflation in the next year or two. More and more, it is looking like deflation is a thing of the past.

In inflation-adjusted terms, housing prices are still about 25% below their 2006 highs. A return to the inflation-adjusted levels of 2006 would be symptomatic of another housing market bubble. We're not there yet, and probably won't be for quite a few years. But if current trends continue, another bubble looks more likely than another crash.

Mortgage rates are very near their all-time lows. Low rates plus increased confidence could easily drive home prices higher. Even if mortgage rates were to rise, that is no reason to worry about housing. Housing has thrived under much higher rates than we have today. Higher rates would likely be symptomatic of a stronger economy and rising confidence, both of which would be supportive of higher home prices.


NormanB said...

Great stuff. Thanks!!!

Kevin Erdmann said...

I have been working on this issue and have come to a much different conclusion. Much higher home prices would not be a sign of a bubble. Home prices had always been in equilibrium with long term real bond rates, until 2007 when the mortgage market broke down, and they have been out of equilibrium since. The collapse of the housing market has been lowering real incomes since then. This is a peculiar time because of the disequilibrium. Rising home prices will be associated with much needed new building, and this will be associated with falling rents.

Here is a very short post about it:

Here's a slightly longer one:

And, if you are interested, at my blog I am on about part 30 of a series on this very issue. I believe that the notion that there is or has been a housing bubble is one of the more damaging ideas related to the present economy.

Benjamin Cole said...

I have always been uncomfortable with the inclusion of housing prices in inflation metrics. Housing is also an investment, given the US tax code.

Moreover, much of the inflation in housing is due to local building restrictions. See Newport Beach.

Should the Fed suffocate the national economy as places such as Newport Beach restrict the supply of housing?

Tricky issue.

Even so, the 35-year trend in the US is towards deflation---and the dollar is rising now.


Benjamin Cole said...

It's official: Q1 GDP dead; inflation deader.
Seriously, if I told you there was a major nation in which the economy was dead in the water and inflation was flat, would you tell that nation to raise interest rates?