The Federal Reserve’s interest rate hikes have helped slow overall price increases, but inflation remains elevated because of the way homeownership costs are priced into key indexes, according to housing expert Jim Parrott and Mark Zandi, chief economist at Moody’s Analytics.
in The Washington Post Editorial On Thursday, they urged the Fed to “declare victory” over inflation and start cutting interest rates. Central bank policymakers meet this week and markets are expecting rates to remain at their highest levels in 23 years.
Though consumer price inflation has fallen significantly from a peak two years ago, it remains above the Fed’s 2% target, prompting Chairman Jerome Powell to push for interest rates to remain high for an extended period of time.
But Parrott and Zandi, co-owners of housing consulting firm Parrott Ryan Advisors and former White House economic advisers during the Obama administration, said that stance was based on a “serious misjudgment.”
This comes from the way the Fed’s preferred inflation measures, the personal consumption expenditures deflator and the consumer price index, attempt to measure the cost of homeownership by estimating rents for similar homes in the neighborhood.
This approach is flawed, they write, because most homeowners don’t have mortgages or have fixed-rate mortgages, so their real costs haven’t changed much. But because the inflation index estimates nominal rents based on rising real-world prices that renters are paying, the implicit costs of homeownership have risen.
Moreover, Parrott and Zandi said it is “virtually impossible” to estimate implied rents in areas where most housing is owner-occupied, or in situations where most rental housing is for multifamily occupants and most owner-occupied housing is for single-family occupants.
If the Fed were to abandon that quirk in its approach, they said, inflation would reach its 2 percent target.
Meanwhile, the Fed’s aggressive interest rate hikes have made it harder to build new homes and discouraged homeowners from giving up low-interest mortgages, exacerbating supply shortages in the housing market, he added.
“The collapse of the housing pipeline is making it more expensive to buy and rent a home, raising the very inflation measure the Fed relies on,” Parrott and Zandi wrote. “The tools the Fed uses to suppress inflation are having just the opposite effect.”
Rent prices are on the rise again after plummeting earlier this year, according to recent data, with people now needing to earn almost $80,000 to afford rent comfortably, up from less than $60,000 five years ago. according to Jiro.
While there are signs that home prices are falling in certain markets, national figures show prices are still rising.
Parrott and Zandi aren’t the only commentators who see the Fed in a bind: Apollo chief economist Torsten Slok said last month that the central bank is caught in a self-defeating loop.
“This can be called the ‘Fed-cut reflexivity paradox’: the more the Fed insists that its next interest rate move will be a cut, the easier financial conditions become and the more difficult it becomes for the Fed to cut rates,” he wrote.
