Monday, July 18, 2016

Dean Baker gets it

Dean Baker at CEPR sees the same problem I do regarding inflation.

It is reasonable to exclude shelter when assessing patterns in inflation since its price follows a qualitatively different dynamic than most goods and services. Rent reflects supply and demand conditions in the housing market. The factor driving rent increases is an inadequate supply of housing.
While higher interest rates will in general be expected to dampen inflation by weakening the labor market and putting downward pressure on wages, this would not be the case with rents. Higher interest rates will slow construction and in this way make the shortage of housing worse. For this reason inflation caused by rising house costs would not be a good rationale for raising interest rates.
Go get 'em Dean!

Goodness, don't read his comments though.  Makes me grateful for my awesome readers/commenters.

5 comments:

  1. Isn't the supply of most goods affected by interest rates? The interest rate is an essential part of the decision to invest in any sort of production.

    Let's say we build more homes, and our rent falls by 10%. Everyone takes those savings and buys a new car. Now we've reduced shelter inflation and replaced it with auto inflation. Overall inflation is the same. I could easily see calls for "but raising rates is not the answer, since that will simply result in fewer cars purchased and less investment in new production."

    The central bank has a commitment to keep inflation low. And I agree, they need not raise rates to accomplish that. But they also cannot disregard inflationary risks because something doesn't fit the narrative. Something will ALWAYS not fit the narrative.

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    1. I think there are a lot of moving parts here, and your conclusions are coming from holding things constant that wouldn't be constant. For instance, the actual payment of rent would be a transfer from tenant to owner. A 10% savings to the tenant is a 10% loss to the owner. And, the house would probably have a lower market value if the rent was lower. So, consumption would be lower, not higher. Or, thinking from the top down, we would also conclude that consumption would be lower, because the new homes would require real capital, which would tend to crowd out other spending or investing. Which, in addition to pushing down consumption would probably push up interest rates. I think you have to be careful about making the analysis to complicated.

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  2. Great to see anyone anywhere "get it" on housing and inflation.

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  3. You could look at it another way. Banks don't lend to average people at very low interest rates. It isn't happening, even in Las Vegas and open access cities. Also, if rates were raised, house prices would come down and banks would lend. Stephen Williamson says keep rates at zero and you will eventually have inflation. I say banks won't lend at zero and you won't have inflation. I thought that was the market monetarist view, but apparently that view is not set in stone.

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  4. What he is saying only makes sense if the only people making use of inflation measures are the people who determine interest rates.

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