How Fed Policies Burn Housing

Today on TAP: Higher interest rates raise housing costs to consumers in multiple ways—the opposite of the Fed’s anti-inflation goals.

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The Fed’s repeated rate hikes have not managed to kill the recovery, but they have still done serious damage. One sector of the economy they have clobbered, which has not gotten enough attention, is housing.

Housing costs, both rental and homeownership, have been rising for reasons that have almost nothing to do with the supposedly excessive demand that the Fed intends to depress. On the rental side, due to long-term policy failures, there is just not enough affordable housing. That gives landlords more power to raise rents. Higher interest rates only make this syndrome worse by making it more expensive to build more apartments.

In the owner-occupied sector, higher rates make it more costly both to buy and to build houses. Mortgage rates have risen from under 4 percent to over 7 percent.

More from Robert Kuttner

Housing starts at an annualized rate are down from their April peak of 1.805 million to 1.425 million in October. In the homebuilding industry, that equals a severe recession. Reduced supply bids up prices. The history of Fed rate hikes shows that the homebuilding sector tends to stay depressed long after the Fed takes its foot off the brake.

The homeownership rate among people under 30 has declined to 35.8 percent. That’s fully one-fourth lower than it was in 2009.

When would-be homeowners can’t qualify for financing, they are thrown back on the rental market, which adds to price pressures. Rents are up 23 percent since October 2019, before the pandemic.

Paul Krugman observes that the overall rate of rent increases has been slowing. This shift predates the Fed’s rate hikes. It evidently has more to do with tenants reaching the limits of what they can pay than with the Fed’s effort to engineer a recession.

Krugman writes that “the rent surge is starting to look like another bottleneck story, in which large price increases were driven by a sudden shift in the mix of things people were buying, rather than a large excess of demand.” And he cites figures by Jason Furman, usually an inflation hawk, showing that the rate of increase in rent levels began slowing well before the Fed’s bout of rate hikes. Rents still rose at an annual rate of 4.7 percent in October.

Overall, the impact of the Fed’s interest rate hikes on housing inflation is exactly the opposite of the Fed’s intent.

There is a classic essay by Charles Lamb titled “A Dissertation Upon Roast Pig.” Lamb imagines that meat used to be consumed raw. One day, a farmer’s house burns down, killing his nine pigs. The farmer notices how good the burnt pig tastes. For a while, other farms mysteriously burn. Then people realize that you don’t have to burn down the house to roast the pig.

Maybe the Fed will eventually realize that you don’t need to burn down the house to reduce sectoral sources of inflation, in housing and elsewhere.

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