How Home Purchases and Rentals Are Key to Bringing Down Inflation: Fed Vice Chair Jefferson Explains
by Wolf Richter • May 20, 2024 • 2 Comments
Fascinating: “Prices that families pay” when they buy homes “can affect their overall well-being.”
The housing sector – rental market and purchase market – is one of the most interest rate-sensitive sectors of the economy and “an important channel of monetary policy transmission,” Fed Vice Chair Philip Jefferson said today at the Mortgage Bankers Association conference. In plaintext, as we’ll see in a moment: The Fed is counting on its higher policy rates to do their thing to the housing market (rental and purchase), with the ultimate goal of lowering demand by households in the broad economy.
It’s good for the Fed Vice Chair to spell that out because the housing industry with its incessant hype and hoopla wants everyone to believe otherwise.
The recalcitrant rents?
With its monetary policy of
5.25% to 5.5% rates and
$1.6 trillion in QT so far, the Fed has been trying to push down demand to remove some fuel from inflation, and that has worked to some extent. Inflation has come down a lot, but then reversed course, with the hugely important measures of housing inflation – Rent and Owner’s Equivalent of Rent –
having remained stubbornly high at 5%-plus in recent months. Against all expectations. And that has turned out to be a bummer.
Jefferson explained away the persistently high rent inflation by pointing at the theory of the “lag effects,” where asking rents take their goodly time before becoming actual rents (the inflation index Rent measures actual rents that current tenants pay, not asking rents which are advertised rents), a theory that we have had to listen to for about 14 months, without seeing a lot of results as rent inflation has remained persistently high.
7% mortgages slowly crimp consumer spending to bring down inflation?
“The current restrictive stance of monetary policy has weighed on the housing market” by bringing “supply and demand into better balance” – thereby
ending the crazy price spike that had occurred during the pandemic – and putting “downward pressure on inflation,” Jefferson said in the
speech, but it hasn’t been enough yet.
One reason why higher policy rates have not been fully transmitted into the economy is the very common 30-year fixed rate mortgage where neither the mortgage rate nor the payments change for the life of the mortgage. “It is often argued that this loan structure dampens the effect of monetary policy,” Jefferson said.
While the average current 30-year fixed-rate mortgage interest rate is at around 7%, the average rate on all mortgages outstanding is below 4% as households refinanced into lower mortgage rates during the pandemic, and are now slow to sell or refinance the home to get a more expensive mortgage.
There is a delay between when mortgage rates rise in response to higher policy rates, and when the total amount in mortgage
payments in aggregate rises as more mortgages with 7% rates make it into the averages.
So “households in the U.S. borrowed over $1.5 trillion in new mortgage loans in 2023. These borrowers include first-time homebuyers, existing homeowners moving between homes, and homeowners obtaining cash-out refinances,” he said.
These households that got 7% mortgages recently will be spending a much larger share of their income on mortgage payments, than households with a 3% mortgage of yore. And as those households with the 7% mortgages will have less money left over to spend on other stuff, “their consumption may be correspondingly lower,” he said.
This is the way higher policy rates work their way into demand for consumer goods and services, by forcing households with 7% mortgages to cut back on buying other consumer goods and services, which reduces consumption, and thereby demand. But it’s a slow process.
“The cumulative effect of a higher interest rate on aggregate mortgage payments grows over time as more new loans are originated at the higher rate,” Jefferson said.
Home “prices” too high?
“The housing sector is where many households have made, or will make, their largest investment. Therefore, the
prices that families
pay for that housing can affect their overall well-being,” Jefferson said without elaborating further.
This is fascinating. The “
prices that families pay” when they
buy the home – not the prices they get when they
sell the home – “can affect their overall well-being.” Purchase prices that are high can mess up a family’s “overall well-being?” Is it finally sinking in? After years of purposefully inflating said home prices?
The conclusion seems to confirm that: “The housing sector is also a key part of the transmission mechanism of monetary policy” – that is trying to bring inflation down. “That is one reason why policymakers will continue to pay close attention to this vital sector,” Jefferson said.