The Fed and Housing – AAF

The phrase “spur more construction” is DC code for “looting taxpayers’ wallets and spending them on housing.” Making a dent in the supply of owner-occupied homes and apartments would require a plot money – certainly in excess of $200 billion – and quickly. These advocates point out (correctly) that if one could snap one’s fingers and create a substantial increase in the supply of houses and rental units, housing inflation would come down. But such a program would be a wild ride.

When the Fed raises rates, mortgage rates go up, the demand for mortgages and houses goes down, and the construction of houses and apartments goes down. But above all, the impacts do not stop there. When fewer units of all types are built, no furnaces are installed, no refrigerators are installed, no carpeting is laid, no furniture is purchased and, in general, demand is slowed in l whole economy. This is an element of reducing inflation to two-thirds of the CPI which is not a shelter.

Housing advocates essentially argue for reversing that or worse by stimulating housing construction and stimulating demand across the economy. Even if housing inflation were to magically disappear, inflation elsewhere in the CPI must fall to 3% to meet the inflation target. The Fed will not be able to tolerate this significant spillover demand stimulus. It will be forced to raise rates further to offset the housing program and reduce both housing and non-housing inflation.

The strategy proposed by housing advocates will do nothing but slow down and make the Fed’s fight against inflation more painful. Admittedly, none of these analyzes is good news. But it’s a reminder that once inflation is baked into the economy, there are no easy right choices. Either live with inflation or accept the consequences of the measures necessary to combat inflation.