Inflation
I think it helps if we decompose the current bout of inflation into three different pieces.
Stimulus-induced goods demand interacting with covid-related production and supply chain delays
Russia/Ukraine-related commodity price inflation (energy, fertilizer, foodstuffs)
Tight US labor market conditions and supply/demand imbalance
When the fed spoke about ‘transient’ inflation it was primarily talking about #1. These factors likely have improved, though the recent covid-related shutdowns in China may affect goods production. The SF Fed has an interesting piece on stimulus-derived inflation.1
The comparison between the actual path of inflation and our scenario in Figure 3 suggests that U.S. income transfers may have contributed to an increase in inflation of about 3 percentage points by the fourth quarter of 2021.
TS Lombard also has a nice (slightly old now) piece on why this cause of inflation was ‘transient.’
The second factor probably can be solved through the price mechanism, but with delays. We can’t grow any more winter wheat for near-term delivery. More energy can be brought on line, but with lags and with physical delivery constraints. Structurally, dealing with #2 over the longer term is part of deglobalization, and this should be inflationary by construct.
The labor market supply/demand is, I’m told, being driven by skill mismatches. For non-economists, the Beveridge Curve is how economists look at the mismatch between job supply and demand. As you can see, following the Coronavirus wave, the curve has shifted materially.
Monetary policy (aka The Fed) cannot directly solve any of these three factors, though by raising rates and lowering demand for labor the Fed might lessen this third effect. Powell is clearly focused on #3:
“The labor market is very strong and extremely tight”
“The inflation outlook has deteriorated significantly”2
Why is Powell worried? Breakeven inflation rates have become untehered to the Fed’s desired long-run inflation target. They will raise rates quickly; there will be blood. Fed will stop only when these collapse back to the range they want.
Housing
I’ve said for two or three PoRs that we need to talk about housing. Housing and autos are two primary goods industries that drive GDP and inflation. Shelter has been a driving factor in inflation:
The index for all items less food and energy rose 0.5 percent in February following a 0.6-percent increase the prior month. The shelter index was by far the biggest factor in the increase, with a broad set of indexes also contributing, including those for recreation, household furnishings and operations, motor vehicle insurance, personal care, and airline fares.3
Looking at the @AltosResearch data, supply remains very tight.
Bill McBride has a nice slide on how available inventory generally relates to price changes.
Demand has stabilized at a very high level seen last spring
Leading to a high proportion of immediate sales
And as a result prices are continuing to be rapidly pushed up (median house price is now $400K)
Now we are at an inflection point. Mortgage rates are up:
And as a result house price affordability has deteriorated and is the least affordable since the housing bubble (but way better than when many of us first purchased).
Interestingly, the supply of housing units relative to population is relatively high, indicating there may be compositional affects going on as well.
The key to addressing housing is to slow immediate demand for housing while simultaneously increasing the available supply. Changing the Fed Funds rate is a pretty blunt instrument; it would be better to raise the mortgage spread over UST by running off the Fed’s mortgage holdings faster. This would slow demand relative to supply.
I’ve had to adjust my thinking as my priors were incorrect - are yours?
Homelessness is not principally driven by poverty.
Homelessness is not primarily driven by mental illness.
Homelessness IS driven by higher rents and insufficient housing.4
We need to build more housing units.
Jordan, Liu, Nechio, Rivera-Reyes, “Why Is U.S. Inflation Higher than in Other Countries?”, FRBSF Economic Letter
Powell, “Restoring Price Stability”, Federal Reserve Board of Governors
CONSUMER PRICE INDEX – FEBRUARY 2022 , Bureau of Labor Statistics
Colburn, Page Aldrein, “Homelessness Is a Housing Problem: How Structural Factors Explain U.S. Patterns”