I think it is plausible that the housing supply problem that I have written so much about has been a key factor in recent business cycles. Note that in both 2000 and 2006, core inflation jumped up, but in both cases non-shelter core inflation was level and all of the marginal increase in core inflation came from shelter. In both cases, this was accompanied by a decline in housing starts - a very small one in 2000 and a large drop in 2006. In 2000, the Fed began lowering rates, and by the end of 2001, rent inflation began to moderate because supply had recovered. In the more recent episode, the Fed Funds rate was still holding steady at 5.25% in August 2007, after 18 months of a supply collapse. Shelter inflation began to moderate at the beginning of 2007, in spite of the supply collapse. Even before the Fed began to lower the Fed Funds rate, demand had been so undercut that housing consumption was decelerating more quickly than housing supply. The problem was so severe that neither housing supply nor shelter inflation began to recover until after QE was implemented.
What's a little frightening about forward inflation expectations suggested by TIPS spreads is that the paltry 5 year breakeven CPI level of 1.2% includes shelter. Markets know that there is no reason for this rent inflation to subside, either because of our metropolitan housing policies or our financial "macroprudence", so this 5 year forward inflation expectation must reflect an expectation of non-shelter core inflation that is basically zero. The shelter inflation issue is structural. Forward bond markets are already predicting a monetary stagnation.
If anything, the CPI measure of shelter inflation (which is mostly rent and imputed rent) is understating the current condition of the market. Here is a CNBC story that references Zillow's recent commentary on rising rents. The comments on that story are a great example of the sort of public sentiment that Fed decision makers must be facing. If housing prices are high, it's a bubble. If rents are high, it's a bubble. If the stock market rises moderately, it's a bubble. If wages rise, it's a bubble. Populists from all political factions seem to agree on these things, and that our only remedy is to suffer - as long as Wall Street suffers too. And, any monetary accommodation is seen as yet another Wall Street giveaway. If the bloodletting hasn't fixed this yet, what else can we do, really, but try another round?
(By the way, I consider the high quality of this blog's comments to be a minor miracle.)