Photo: -Marlith- via flickr
Much has we’ve been talking about the meaning and importance of a rigid 2% inflation target in America, it would be useful to have a tangible example to help illustrate the point. Kathleen Madigan obliges:The market for rental units is out of whack. The supply among rental housing is the tightest in more than a decade as only 8.8% of units were vacant in the first quarter. And given the steep fall in homeownership rates in the U.S., the demand for rental units is the highest in 15 years.
The imbalance isnt just a headache for those seeking to lease a home. It could cause a migraine for Federal Reserve officials.
That is because rentswhich had been held down during the recessionare rising. According to the Commerce Department, the median U.S. rent was $721 per month in the first quarter, up 5.6% from year-earlier levels…
Actual rents influence what homeowners think their own homes would rent for. And within the consumer-price report, rents and owners equivalent rent account for 40% of the core index that excludes volatile food and energy items. In March, yearly shelter inflation was running about 2.1%, setting a floor under core inflation, which was running at a 2.3% annual pace.
New permits for housing in structures containing 5 or more unitsessentially, apartmentswere up 24% from February to March and nearly 60% from March of 2011. That is a direct consequence of higher rents: rising prices generate rising supply (in the absence of structural barriers to new supply creation). Rising supply, of course, translates into a larger contribution to growth from residential investment and a larger contribution to hiring from construction. This is the market clearing, and rising prices are the mechanism through which it clears.
Unless, of course, the Federal Reserve restrains the process of clearing because it’s nervous about a period of above-target inflation. Now, markets might still get there eventually. But given a strict pursuit of low inflation, the needed rise in relative rents requires a decline in nominal wages. That sort of thing occurs very slowly and at the cost of high unemployment. So now we stand back and watch; will the Fed allow the recovery to develop in a healthy way, or will it hold it back, ensuring that unemployment remains elevated for a long period of time in order to keep inflation comfortably close to the 2% ceiling?