Monday, July 20, 2015

Inflation and Housing Starts aren't encouraging

Inflation for June is a bit worrisome.  Indicators are moving back into dangerous territory, with shelter inflation moving up and "Core minus Shelter" inflation moving down.  I take this as a signal of decreasing monetary accommodation on both counts, through currency management regarding the CmS inflation and through credit constraints in the Shelter inflation (which limits housing construction).  Nominal spending is stagnant because of currency management and real consumption is stagnant because of credit constraints in housing construction.  The combined signal these give is of a moderate inflation, which looks like reasonable monetary policy if the supply problem isn't accounted for.  So, not only does this signal a monetary policy that is currently too tight, but it is likely to produce a monetary policy reaction that is even tighter.

I have been somewhat sanguine about this apparent problem because, adjusting a version of the Taylor Rule for this housing supply problem still suggests an adjusted Taylor Rule target rate of about 2%.  We have an economy that is operating at full expansion levels, with credit markets that should reflect higher interest rates - healthy industrial credit growth, recovered corporate profits, low unemployment.  So, while the extreme shortage of investment outlets in real estate holds interest rates down and the lack of credit expansion and employment in home construction (along with demographic headwinds) will probably keep a cap on real and nominal GDP growth even at the zero lower bound, it may be possible that the Fed could push interest on reserves up to 2% without affecting demand for credit substantially.  Demand for credit isn't low because of the discretion of borrowers.  It's low because of the discretion of banks and regulators.  It looks like mostly a regulation issue to me, since I would expect a market response to be through interest rate spreads instead of being being strictly through supply.  In today's real estate environment, many homebuyers would be willing to pay a higher spread if that was their only obstacle to ownership.

In any case, if the Fed begins to push rates up and that quickly triggers a drop in currency growth, growth in excess reserves, or a drop in long term interest rates, I would consider those to be negative signs.  If that does happen, I don't see the FOMC turning on a dime and quickly re-evaluating.  There seems to be significant risk there.  On the positive side, most of the recent weakness in yields has come from the movement forward in time of the expected first rate hike.  The slope of the yield curve coming after the first hike remains low, relative to previous recoveries.  But, the level of very long rates has been recovering this year.  I take this as a good sign.  If far forward Eurodollar rates remain strong as we contimplate the first rate hike, I take that as a sign that we can handle a rising short term rate.  Fortunately, it looks like we have several months to see how things develop.

Housing starts were also reported Friday.  Single family home starts continue to grow slowly, reflecting the moribund mortgage market.  Multi-unit building had looked like it was topping out, which I expect to be permanent.  I have blamed the low level of multi-unit building in the last several recoveries on the regulatory limits to building in the core metropolitan areas.  The extremely low continuing rates of new building in the major metro areas suggest that this is still the case.  But, new multi-unit building permits have surged for two months now.  Could multi-unit housing finally be poised to make up for the lack of single unit housing?  The added permits from the previous couple of months appear to have come from New York City. Unfortunately, it looks like the spike is the product of a regulatory deadline and probably won't persist.


  1. How the heck are you calculating that curve you're calling the Taylor rule? Did you run some kind of regression using the output gap and CPI against the actual fed funds rate, or are you varying the inflation target throughout the period on the chart?

    1. Oh I see, you track something else and attach John Taylor's name to it.

      I'd ask why you track that rule in particular but I've lost interest because you've attributed it to Taylor even though it has nothing to do with him.

    2. Anonymous is right. My starting point was a simple to calculate rule which Greg Mankiw proposed, but looking at Mankiw's blog, I see that he refers to it as "Mankiw Rule" on his chart. I think I have been careful about identifying this as "A version of the Taylor Rule" and identifying my alternative as an "adjusted Taylor Rule". Am I being inappropriate or confusing? Do others feel the same as Anonymous? I'm open to suggestions.