Deflation pressure not just from housing
It will take more than a recovery in housing to reignite inflation in the U.S. economy, a state of play that argues for the continued threat of deflation and a Federal Reserve that is pinned to the mat, unable, even if willing, to raise interest rates.
The strong disinflationary forces in the United States are deeper and wider than a simple, if bloody, aftermath of a housing bubble.
Many took encouragement from a report by Reis Inc that apartment rents in the United States rose in the first quarter for the first time in a year and a half even as the apartment vacancy rate stayed at an all-time high of 8 percent. Besides indicating a possible recovery in jobs and household formation, which tracks jobs, there is a hope that stabilization in housing values and rents would remove a powerful disinflationary force.
However, the downward trend in core inflation, while influenced by weakness from housing, is far broader.
“A close examination of recent inflation data shows that the weakness in housing costs is representative of a broad pattern of subdued price increases across most consumption goods and services and is not distorting the broad downward trend in core inflation measures,” Federal Reserve staffers Bart Hobijn, Stefano Eusepi and Andrea Tambalotti wrote in the Federal Reserve Bank of San Francisco Economic Letter.
“Weakness in the housing market has reduced the inflation rate of the housing components of core inflation. Yet, this very substantial decline in the rate of housing inflation has not been isolated. Rather, it is indicative of a much wider decrease in inflationary pressures observed since the peak of the financial crisis,” they wrote.
Could it be that the same forces constraining housing are also constraining inflation in the rest of the economy?
In other words, our problems lie not just in our houses, but in ourselves, our overstretched balance sheets, our poor job prospects and our constrained incomes.
Housing, on this reading, is not a first cause of the crisis or the deflation which it may bring but simply one more symptom.
Leverage allowed housing to skyrocket and now the destruction of leverage is hurting house prices despite huge efforts by the government to prop up the asset class.
DISCRETIONARY MEANS YOU DON’T HAVE TO
The San Francisco Fed letter looked at the core personal consumption expenditures price index (PCEPI), an indicator closely watched by Fed policy makers which covers what consumers buy but excludes volatile things like food and energy prices. While house prices are an important force in inflation they do not contribute directly to measures of inflation. The PCEPI attempts to capture changes in the price of shelter, as opposed to the investment value of housing, by looking at rents and something called owners’ equivalent rent, essentially an estimate of what a house owner would be paying in rent for a the use of a comparable housing unit.
But while housing inflation within the PCEPI has crashed from a 4.5 percent annual rate in 2007 to 0.3 percent in February, it only represents 18 percent of the entire basket measured. If you strip out housing, core PCEPI has fallen to 1.6 percent in February from 2.6 percent in July 2008. Both measures seemed to have bottomed in September 2009 but have since resumed an ominous downward march.
So, if it is not just housing, what exactly is helping to push inflation lower?
Well, it’s not automobiles, which have seen strongly accelerating prices. That is probably because cash for clunkers helped to bring consumption forward and made buyers less price-sensitive. Given the structural oversupply in auto manufacturing capacity worldwide, that cannot be expected to continue.
The stuff that is suffering is highly discretionary items. Public transportation, which includes airfares, was influenced by the fall in the price of fuel, as well as lower demand by business travelers and holidaymakers. Hotel accommodation, luggage, jewelry and multimedia equipment all have posted large declines in inflation.
Falling inflation outside of housing, therefore, is painting a picture of broad deflationary pressure, and of households struggling to keep their heads above water and cutting back on discretionary spending.
This is not surprising. The housing bubble was the biggest and probably the most important manifestation of a credit bubble and the debt-financed consumption binge that followed. As it burst it had and continues to have a strong downward effect on inflation. But even if you foresee rents recovering, the overall threat will continue to be the deflationary force of debt repayment and destruction.
Whatever you mean by “extended” and whatever you mean by “period”, the Fed’s extended period of very low rates is going to last a long time.