Will a Housing Recovery Drive Up Inflation?

Will a Housing Recovery Drive Up Inflation?

If the housing market gathers momentum, could rising home prices put upward pressure on inflation?

Two researchers at the Federal Reserve Bank of Atlanta are interested in the question, because housing is the most important component of the consumer price index:

What makes the answer to that question a little tricky is that home prices do not factor directly into the CPI, because houses are considered assets, not consumer goods. Instead, the CPI factors in the implied rent owners pay by living in their homes rather than renting them out to others. The Bureau of Labor Statistics includes measure of this implied rent, called "owners' equivalent rent," (OER) in its calculation of the CPI. (The CPI also reflects changes in rents.)

Where it gets even trickier is when it's considered that higher house prices don't necessarily entail a higher OER. The Atlanta Fed analysts note that if landlords hike rents in response to elevated housing prices, renters might buy more houses, thereby lowering prices in the rental market and lowering the OER.

To figure out the impact of such a substitution effect (i.e., renters substituting homes for rent when rent prices go up), the researchers compared housing prices to OER, and find that the long-term trend is for OER to move with housing prices:

But in the short-term, home prices and implied rent to homeowners are negatively correlated:

So the Atlanta Fed economists tentatively conclude that in the short term, rising house prices will lower OER and thus dampen inflation. In the longer term, though, higher prices will also mean higher rents. Read the whole analysis.

Joseph Lawler is editor of RealClearPolicy. He can be reached by email or on twitter.

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