Wednesday, August 20, 2014

July Inflation Update

Here are updates on a couple of charts I introduced in this post. 

I have been looking at core inflation without shelter.  To the extent that very low long term interest rates are driving home prices, shelter inflation may be a countercyclical indicator.  (To be clear, I think rent equivalent is the appropriate inflation measurement to use.  The notion that a context of moderate rent inflation, very low interest rates, and rising home values is inflationary is dangerously wrong.)  In this context, a crippled credit market is artificially curbing demand for homes, reducing the supply of new homes.  The effect is that an undersupply of homes is leading to rent inflation.  As credit markets loosen, home supply will respond.  Oddly, in this way, demand recovery will be a supply recovery.  Recovery of real estate credit markets may actually suppress nominal GDP relative to real GDP, as it is (correctly) measured.

In the first graph, we can see that core-less-shelter inflation swung down.  All the net core inflation in the month came from shelter.  This is the second month of moderating inflation after several months of increasing inflation, which clouds the picture of where inflation my be leading as QE3 ends.

The continued strength in shelter inflation suggests that we are still early in the credit market recovery.  The real estate recovery should create a bit of a virtuous circle, as the continued re-inflation of property values feeds back into credit creation and reduces mobility frictions.  As long as this is allowed to continue, home prices should continue to rise, home supply should increase, and rent inflation should moderate.

The strong level of rent inflation is a sign of a recovery in household formation, which is a signal of the strengthening underlying economy.  Bank credit continues to show strength as the QE3 taper winds down.  The first half of 2014 has been the first time since the crisis that bank credit has been expanding in quantities similar to pre-crisis levels.  However, most of the increase has been through very strong Commercial and Industrial Loan growth.  As real estate credit continues to recover, real growth should continue to get a goose.  I will look at this some more in follow up posts.

No comments:

Post a Comment