The Federal Reserve’s rate hikes have helped slow overall prices, but they’re also keeping inflation steady because of how home ownership costs factor into key metrics, according to housing expert Jim Parrott and Mark Zandi, chief economist at Moody’s Analytics.
In one Washington Post published on Thursday, they called on the Fed to declare victory over inflation and start cutting rates. Central bank policymakers are meeting this coming week and markets expect them to keep rates steady at 23-year highs.
While consumer inflation has fallen sharply from its peak two years ago, it remains stuck above the Fed’s 2% target, prompting Chairman Jerome Powell to keep rates higher for longer.
But that position is based on a serious misjudgment, according to Parrott, who co-owns housing consulting firm Parrott Ryan Advisors and a former White House economic adviser during the Obama administration, and Zandi.
It stems from the way the personal consumption expenditure deflator, the Fed’s preferred inflation gauge, and the consumer price index attempt to measure the cost of home ownership by estimating the rent for a similar home nearby.
The approach is flawed, they write, because most homeowners don’t have a mortgage or have a fixed-rate mortgage, meaning their current costs haven’t changed much. But since inflation measures are pricing a notional rent based on the increase in real-world prices that renters are paying, homeowners’ implicit costs have risen.
Additionally, Parrott and Zandi said it is virtually impossible to estimate implicit rent in communities where the majority of homes are owner-occupied or in situations where most rental inventory serves multifamily residents while owner-occupied inventory is serves the residents of a family.
If the Fed removed that quirk in methodology, then inflation would be on target at 2%, they said.
Meanwhile, the Fed’s aggressive move has worsened tight supply in the housing market by making it harder to build new homes and discouraging homeowners from giving up their low mortgage rates, they added.
This disruption in the housing supply pipeline is driving up the cost of buying and renting, raising the very measure of inflation the Fed is relying on, Parrott and Zandi write. The tool the Fed is using to reduce inflation is doing just the opposite.
The latest data shows that after cooling off earlier this year, rental prices have risen again. To comfortably afford rent, you need to make almost $80,000 a year, up from less than $60,000 five years ago, according to Zillow.
And while there are some signs of weakness in home prices in certain markets, the nationwide numbers still show that prices are rising.
Parrott and Zandi are not the only commentators who see the Fed stuck in a box. Apollo chief economist Torsten Slk said last month that central bankers are in a self-destructive loop.
You might call this the paradox of Fed tapering reflexivity: The more the Fed insists that the next move in interest rates is a cut, the more financial conditions will ease, making it harder for the Fed to cut. , he wrote.
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