The Fed can’t see the next potential economic meltdown because it’s still looking in the rear-view mirror, seeing nothing but High inflation.
The risk arises because the CPI and PCE – the two most important measures of inflation – have a fatal flaw in the way they measure shelter costs.
“ If you get your housing prices wrong, your view of inflation will also be wrong. “
As a result of this imbalance, price indicators will miss a crucial turning point in the attempt to restore price stability. The Fed is winning a big fight in the fight against inflation, but policymakers don’t believe it. This means that the Fed is likely to raise interest rates very high and keep them high for a long time while waiting for confirmation, which will come too late.
Powell didn’t understand that
Fed Chairman Jerome Powell was asked about this at his last press conference a week ago after he raised rates again and promised to raise rates more frequently in the coming months.
“I think housing inflation will remain high for some time,” Powell said. “We’re looking at it going down, but it’s not clear exactly when that’s going to happen… you just have to assume it’s going to be very high for a while.”
Powell didn’t even hint that the Fed was making significant progress in controlling shelter costs. Powell may have been just trying to stay aware of the hard-line message he was trying to get across, but, again, Powell and other policymakers may not really understand it.
Make no mistake, housing prices are dropping rapidly, even if this fact does not appear immediately in official inflation statistics due to the way price indices are created. Shelter is a large part of the typical household budget and accounts for a third of the CPI (and 15% of the PCE price index). If you get your housing prices wrong, your view of inflation will also be wrong.
Home prices fell at an annual rate of 6.9% in July after that Historic increase In housing prices more than 20% per year, according to resale indicator reported by the Federal Housing Finance Agency on Tuesday. The Case-Shiller index, the three-month average, is down at a 2.9% annual rate.
The Fed should rejoice at this news, because they engineered it by raising interest rates overnight by a force of FF00,
Resulting in higher mortgage rates. The Fed is also reducing its holdings of mortgage-backed securities through quantitative tightening, which will tend to raise mortgage rates.
The Fed appears to have succeeded in eliminating a major inflationary factor: rising house prices. In the long run, of course, the only way to control housing inflation is to provide affordable housing, and to bring supply in line with demand.
We are all rented now
However, it is not the price of homes that determines the measurement of shelter costs in price indices, and actual out-of-pocket expenses for mortgages, taxes, insurance and maintenance play no role in the government’s assessment of the cost of living.
Instead, the government uses the rental unit price and It assumes homeowners pay similar costs, Although about two-thirds of adults do not rent their homes, but live in their own homes. A third of the mortgage has been paid off.
The assumption that homeowners are like renters is wrong. For renters, shelter costs represent about 34% of their personal spending each year, according to the Bureau of Labor Statistics. Consumer spending survey. For homeowners with a mortgage, the rate is 27%. For homeowners who do not have a mortgage, the rate is 21%. And remember, homeowners also accumulate equity.
Any assumption that the cost of living for the 84 million home-owning families should be measured by what the 47 million renters pay is not just absurd, but fatally flawed. In times of low inflation this may be acceptable, but in times of high inflation this assumption sends a misleading message.
The apartment house rental price doesn’t track the purchase price perfectly, and tends to lag by 12 to 18 months. This means that the fall in house prices in July (and beyond, likely) won’t really be evident in the rental price until next summer. It won’t fully show up in inflation data until then either.
higher for longer
The Fed policy is to keep raising interest rates until inflation data tells them to stop. But this policy is regressive in nature. This means that the Fed is likely to ignore any signs of progress in curbing inflation expectations, or in reducing effective demand by destroying wealth and slowing income growth.
This means that an unnecessary hard landing is likely, with more pain for the American economy and its people that is necessary. Not to mention what you do for tIt is the rest of the world.
Rex Nutting is a columnist for MarketWatch who has been writing about economics for over 25 years.