There is an interesting aspect to the recent rise in the inflation rate that the media have not really explored. The biggest factor in the higher than expected May measure was a jump in rent. (The two rental indices, owners' equivalent rent and rent proper, account for nearly 40 percent of the core consumer price index [CPI].) One explanation for more rapid increases in rents is that people who cannot afford to buy houses, due to higher mortgage rates, are now looking to rent. The Census Bureau's data on vacancy rates gives us evidence to support this position. Rental vacancy rates have fallen by almost a full percentage point from their record high 10.4 percent in the first quarter of 2004. At the same time, the vacancy rate in ownership units has increased from 1.7 percent to 2.1 percent over this period. (There are twice as many ownership units as rental units, so the overall vacancy rate is basically the same over this period.) Insofar as this story is true, it implies a very interesting dynamic. We have the Fed raising interest rates to combat inflation. This effort leads people to switch from homebuyers to renters, thereby placing upward pressure on rents. Since rents appear in the CPI, and home sale prices don't, this switch raises the measured rate of inflation, which in turn puts pressure on the Fed to raise interest rates even more. The unraveling of the housing bubble can create these sorts of vicious circles.
--Dean Baker
