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Inflation and the Housing Market

Inflation and the Housing Market

It all comes down to supply and demand.

For the first time since the 1980s, Americans are dealing with 8%+ inflation in consumer prices. American homebuyers, however, have been dealing with inflation since 2012. The typical home costs double what it did in 2012, but the typical worker is only earning 35% more. There are many lessons to be learned from a decade of home-price inflation as we attempt to solve today’s widespread consumer-price inflation. Like everything in economics, it comes down to supply and demand.

Home-price inflation is largely due to constrained supply. According to Freddie Mac, the United States is short approximately 4 million homes. We built fewer homes in the 2010s than any other decade going back to the 1960s. And we aren’t making the best use of the land in some of the most desirable places to live due to restrictive zoning laws. 

Because we don’t have enough housing, the price of homes more or less reflects how much wealthy people are willing to pay. To put it simply: if there are 10,000 homes for sale in a city, but 30,000 families are looking to buy a home, only the wealthiest third of families are able to buy one. The other two-thirds lose when they try to compete because they don’t have as many resources—like cash or credit—to win a home. 

Because wealth inequality is increasing, the population’s richest third is getting even richer. And it’s becoming increasingly difficult for families in the bottom two-thirds to catch up. It’s not enough to work a second job or cut back on other expenditures. The goal post keeps moving.

The solution is to build more homes. If there are only 10,000 homes for every 30,000 homebuyers in a city, then we should build at least 20,000 more homes in that city. We can accomplish this through proper urban planning, including dense housing and efficient transit. Ideally we wouldn’t only build for our needs today but also for the needs of the next generation of homebuyers. 

Some homeowners will fight this. Many of them do not want dense housing in their neighborhood because a lack of housing increases their home’s value. But this is misguided. Higher housing costs make everything more expensive in a city. When low- and middle-income families can’t afford to live in a city, it becomes more difficult and more expensive to employ the workers that make a city livable, such as teachers, police officers, and childcare workers. 

What does this have to do with the inflation we are seeing now? Like the housing market, the economy is supply constrained. It isn’t living up to its full potential. The reason we are supply constrained is that—just as we are behind the curve on building homes—there are other segments of the economy where we’re behind too. For example, if we were ahead of the curve on electrification and renewable energy, inflation in gas prices wouldn’t be so painful. If we were ahead of the curve on planning and budgeting for a pandemic response, we wouldn’t have needed to shutdown the economy for as long as we did. It’s a big reason why we’re feeling this inflationary pain from reopening the economy. We are also falling behind the curve on climate resilience. It will be more costly for the government to put out wildfires or repair flood damage than it would have been to invest in fire and flood prevention. 

Not every economic supply constraint can be solved through better policy, and we don’t always know what the better policy is. But housing supply, renewable energy, public health, and climate change resiliency strike me as obvious, unforced errors. 

There’s not much to be done about present inflation that won’t be painful. When the Fed raises interest rates to slow inflation, it hurts borrowers. Higher interest rates make it more expensive to borrow to buy a home, buy a car, or finance higher education. But we can plan and do the work today to reduce the pain of our next inflation catastrophe.

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