Oregon Office of Economic Analysis

There’s no question that the cost of housing is increasing significantly faster than inflation overall. In fact, in the past year or two, inflation excluding housing has actually been zero or negative. That is, if you take housing out of the calculation, there is no inflation in the economy.

This is potentially worrisome for a few reasons however I want to focus on one in particular, based on recent conversations with the Governor’s Council of Economic Advisors. One concern is that as core inflation firms or picks up closer to the Federal Reserve’s target, the Fed will raise interest rates to head off future inflation. Ok, but what if that is entirely due to housing and not due to a general increase in inflation across the board? A sector specific shock — in this case rising housing costs and inflation — is different than a general overheating economy which is the Fed’s primary concern here. Furthermore, the housing inflation is due to a fundamental lack of supply, which is something monetary policy isn’t designed to deal with either. Such a scenario can lead to policy mistakes, or so the thinking goes.

Well, as logical as that argument seems on its face, there are a number of counterpoints and clarifications that, thankfully, make it much less of an issue. Noted fed watcher and University of Oregon professor Tim Duy helped set the record straight in our conversations.

First, look at national and not local inflation. Not all housing markets are showing robust increases and the national figures are more muted.

Second, housing is an important part of so-called sticky inflation. These items are less volatile over time, hence the term sticky. They are important in setting inflation expectations about the future. Eroding inflation expectations in recent years are a major concern, so items like housing that are rising are actually helping this situation, despite the strains on household budgets.

Third, Bill Conerly suggested we actually do the math on housing’s contribution to overall inflation. As shown below, that contribution is right in-line with historical patterns. So the issue is not so much housing inflation, at least nationally, but the fact that inflation outside of housing is so low. This is also true if you exclude food and energy. 

Finally, at a more fundamental level, you should really be looking at PCE instead of CPI. The simple reason is that the Fed targets PCE and the composition of the basket is different. For example, Housing and Utilities account for 18% of actual Personal Consumption Expenditures in 2014 and 2015. Conversely, housing in the CPI basket is 42% nationally, more like 44% locally. Housing’s 42% can be broken down into Shelter (33%), Fuels and Utilities (5%) and Furnishings/Operations (4%). 

National housing trends as seen in the actual consumption data do show milder trends than strictly looking at rental increases in popular, coastal metros. That said, it’s not that those rental increases are not a problem, they clearly are. Rather it is much less a concern for monetary policy makers.