(Bloomberg Opinion) -- If you want to know what stagflation looks like, check out the housing market. The conditions that existed during the 1970's — high inflation and stagnant output — are happening already in this segment of the U.S. economy, illustrating the challenges ahead for consumers, industry players and the Federal Reserve.
Though homebuilders continue to expand construction in response to elevated demand, the number of homes actually being completed has been stagnant because of persistent supply chain problems. This stagflation is a headache for homebuilders and homebuyers, but it's a benefit for many existing homeowners — and therein lies the Fed’s predicament as it seeks to lower inflation.
U.S. home prices rose by 18.8% in 2021, according to the Case-Shiller U.S. National home Price Index. Yet real residential fixed investment fell in the second and third quarter of 2021 and was essentially unchanged in the fourth quarter. Homebuilders are trying to build more homes, but the housing supply chain still hasn’t been able to increase production to match. On a seasonally-adjusted basis, completions of single-family homes have been unchanged since August 2018.
There are two ways to address this stagflation. The good way would be to improve the supply of resources like garage doors, cabinets and windows that are holding back the homebuilding market. That's something policymakers don't really have the tools to address, at least in the short run. The second way would be to restrict credit or raise mortgage rates high enough to reduce home-buying demand, thus reining in home prices.
But that's a challenge too. The inventory of new and existing homes for sale is at a record low. And as Bill McBride of the Calculated Risk blog has noted, we're in the home-buying sweet spot, from an age perspective, for the large Millennial generation, ensuring strong demographic demand for the next several years. Raising interest rates high enough to put a dent in the housing market would throw the rest of the U.S. economy into recession first. We don't have, or aren't willing to use, policy tools that would cool off housing demand while leaving the rest of the economy unaffected. At the peak of the credit bubble the housing market was the most fragile part of the U.S. economy. Today it's arguably the most robust, from a demand standpoint.
That's a challenge for the Fed as it works to get inflation under control. Home prices don't feed directly into the calculation of consumer price inflation, though to the extent rising home prices lead to rising rents, there will be an impact. The bigger impact might be the wealth effect for middle-class homeowners.
Sixty-five percent of American households own their homes. Stocks and bonds are held primarily by the rich, but it's home equity where the middle class has its wealth. And right now that wealth is booming, having risen by more than one trillion dollars each of the past three quarters. At the peak of the mid-2000's housing boom that number was more like $450 billion a quarter.
That's wealth that households could tap to push their spending on goods and services higher, which would likely flow through into higher inflation. It's also wealth they can use as a backstop for their spending as inflation reduces the purchasing power of their incomes, and as higher interest rates raise the cost of borrowing.
Taking out a home-equity loan at a rate of 4% or 5% to support higher spending when your income is being squeezed by inflation might not be the wisest decision, but it's still a much lower borrowing cost than a credit card. And for a middle-class household that's gained $100,000 in home equity over the past couple years — not an uncommon scenario in much of the country — it's easy to see the appeal.
In 2021 the hope was that inflation was a result of short-term factors related to the reopening of the economy and industry-specific shortages of key inputs such as semiconductors that went into automobiles. But as inflationary pressures have broadened over the past several months, our dysfunctional, stagflationary housing market is turning into a relentless wealth-generation machine for homeowners. That’s going to make it much harder for the Fed to rein in the expanding spending that’s pushing inflation higher.
More From Other Writers at Bloomberg Opinion:
- Weighing Up Risks of Stagflation and Armageddon: John Authers
- Powell Threads Needle in a Swirl of Uncertainty: Jonathan Levin
- Why the Housing Market May Shrug Off Higher Rates: Stephen Mihm
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.
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