Thursday, July 20, 2017

June 2017 CPI

The story continues.  Shelter inflation (YOY) remains at 3.3% and core minus shelter inflation remains at 0.6%.  Core minus shelter inflation has been in a fairly steady decline since the first rate increase in December 2015.  It seems increasingly plausible that the target Fed rate is above the natural rate so that inflation will continue to decline unless the target rate is decreased.  That isn't going to happen.  The available choices appear to be either raising the Fed Funds rate or keeping it at about 1%.  If it needs to be decreased, the Fed will be behind the curve.  I continue to tentatively expect a slow-motion contraction, although without much movement in prices of the major asset classes.  Bond yields don't have much room to fall, housing is being held in depression mode by credit policies, and I don't see any reason at this point for equities to collapse, although that would depend on global economies, future NGDP shifts, etc.

Hsieh and Moretti have made several attempts at estimating the loss of economic activity due to Closed Access housing policies, ranging from around 10% to much higher estimates.

It seems to me that simply comparing consumer inflation with and without shelter inflation gives a good first estimate of the lower range of this cost.  There was a jump in the late 1970s of about 10% in consumer costs due to rent inflation and since the mid 1990s, there has been another rise of 10% to 15%, with a brief pause from 2008 to 2012 because of the foreclosure crisis.  Considering that this doesn't reflect any particular rise in building costs, this seems like a decent estimate of the payment of economic rents to Closed Access real estate owners.

That is just the measure of the extra costs to workers and firms that reside in those cities.  There are additional costs to the US economy due to the exclusion of workers from those cities - workers that didn't have the opportunity to earn additional income which would then be funneled to urban real estate owners because the high cost led them to remain in other cities.  Maybe the higher estimates from Hsieh and Moretti of something like 50% since the mid 1960s aren't out of line.


  1. Great charts. You can see that shelter inflation CPI peaking in 2002 and 2007…and now?

    As you say, fat chance the Fed is going to reverse course even on interest rates, and as for more QE or helicopter drops, you might as well hope for manna from heaven.

    For a long time I have wondered what the Fed would do if the economy softened and interest rates and inflation were still near zero. The Japan-ish scenario, in other words.

    Regrettably, maybe soon I will find out.

    Interesting question: Are large trade deficits and tight property zoning, alongside a banking system heavily exposed to real estate, an inherently unstable situation?

  2. If I understand you correctly because core - shelter is falling now the Fed should be more inclined to loosen. What about the opposite in 2010 when core - shelter spiked to 3%, and was at 10-15 year highs from 2008-2010. How do we select our indicators?

    1. The Fed, as an inflation targeter, was legitimately thrown off by high inflation in 2008. In terms of their own targets, in this way, you are correct that in 2008 there was reason to tighten. In 2011, that was probably from QE2. I think the QEs were more effective than they are generally given credit for. But, when they were stopped, inflation would fall again. Monetary policy had an asymmetric effect during this time, because we were engaged in a passive destruction of working class balance sheets by closing down credit access in those markets and pushing their home prices down 15% or more as the owner-occupier low tier market was destroyed. When the QEs were on, they countered that problem. When they were off, the lack of credit growth led to disinflation. Under QE, we probably weren't too tight.

      All that being said, if the Fed is targeting 2% inflation, then inflation between 2-3% is one reason for potential targeting, but in the midst of a national credit catastrophe, one might still expect some accommodation.
      There are several layers of criticism here, and I might not be clear enough about them when I talk about them:
      1) the target mechanism is mis-specified (rent inflation is non cash)
      2) the target mechanism is wrong (NGDP over inflation targeting)
      3) the Fed has missed their own target
      4) the Fed would like to provide stability, but the populace wouldn't stand for it
      5) Some members of the FOMC share the public's demand for instability

      Throughout a lot of the crisis, while I think the Fed is part of the problem, it really is generally problem number 4, with some #5 thrown in. Even today, Bernanke, Geithner, etc. have to apologize for having stabilized markets.