The Federal Reserve’s rate hikes have helped slow overall prices, but they also keep inflation low because of the way homeownership costs are factored into key metrics, according to housing market expert Jim Parrott and Mark Zandi, chief economist at Moody’s Analytics.
IN Washington Post review article on Thursday they called on the Fed to “declare victory” over inflation and begin cutting rates. Central bank policymakers will meet next week and markets expect them to keep rates steady at 23-year highs.
While consumer inflation has fallen sharply from its peak two years ago, it remains above the Fed’s 2% target, prompting Chairman Jerome Powell to keep rates higher for longer.
But that position is based on a “serious misconception,” according to Parrott, who is co-owner of the housing consulting firm Parrott Ryan Advisors and a former White House economic adviser during the Obama administration, and Zandi.
That’s because the personal consumption expenditure deflator, the Fed’s preferred measure of inflation, and the Consumer Price Index attempt to measure the cost of home ownership by estimating the rent for a similar home nearby.
They wrote that this approach is flawed because most homeowners have no mortgage or a fixed-rate mortgage, meaning their actual costs haven’t changed much. But as inflation measures estimate imputed rents based on the rising real prices renters pay, the implicit costs to landlords rise.
Additionally, Parrott and Zandi said it is “virtually impossible” to estimate implicit rents in communities where the majority of homes are owner-occupied, or in situations where most rental housing serves multifamily residents while owner-owned inventory serves residents one family.
According to them, if the Fed abandoned this feature in the methodology, inflation would reach its target of 2%.
Meanwhile, the Fed’s aggressive rate hikes have worsened supply shortages in the housing market, making it difficult to build new homes and discouraging homeowners from forgoing low mortgage rates, they added.
“This breakdown in the housing supply system raises the cost of buying and renting, raising the very measure of inflation that the Fed relies on,” Parrott and Zandi write. “The tool the Fed uses to reduce inflation does exactly the opposite.”
Latest data shows that after a cooling earlier this year, rental prices have started to rise again. To comfortably afford rent, you’d need to earn nearly $80,000 a year, up from less than $60,000 five years ago. in accordance with Zillow.
And while some markets are showing some signs of declining home prices, national numbers still show prices rising.
Parrott and Zandi aren’t the only commentators who think the Fed is stuck in a box. Apollo chief economist Thorsten Slok said last month that central banks were at an impasse.
“You could call it the reflexivity paradox of the Fed’s rate cuts: the more the Fed insists that the next move in interest rates will be a cut, the more financial conditions will ease, making it harder for the Fed to cut,” he wrote.