the ecomony

Consumer inflation and home prices are unrelated (and always have been)

Both home prices and the rate of consumer inflation have dropped dramatically in this recession, leading many skeptics to believe that the drop in inflation is attributable only to the drop in home prices. If the price paid for homes were excluded, they argue, we would actually see rising consumer inflation. A recent report from the San Francisco Federal Reserve Bank disproves the skeptics’ home price argument. The truth: while rental pricing is an integral factor in consumer inflation, home pricing has no effect whatsoever upon consumer inflation.

Moreover, even the effect of rental pricing is negligible. When core inflation is recalculated without considering any influence from the housing market, the inflation rate-change trend line remains essentially unchanged. In fact, housing accounts for a difference of only .2% in the inflation rate of the core PCEPI. More importantly, the asset price paid to actually purchase a home never even enters the picture.

Home prices — the focus of inflation skeptics — never exert any pull upon the rate of consumer inflation, and never have. This is because real estate is an asset, not a consumer good: indeed, the only consumable aspect of real estate is the right to live on residential property, expressed by its rental rate—never the price someone is willing to pay for the right to own the property. In all other respects, home prices in a boom or bust behave the same as the prices of other assets, like stocks or bonds. Moreover, the price paid for a home never sets the rental value for that home.

Changes in home pricing do not affect rents, which only change gradually. Fear mongers believe that changes in real estate asset pricing will affect the rate of consumer inflation (which includes rental rates, and nothing more) creating a hidden risk of increased inflation. They are wrong, however, and always have been.

Copyright © 2011 by first tuesday Realty Publications, Inc.