With the midterm elections approaching, President Joe Biden has little choice but to talk up the economy. Unfortunately, the economy is looking increasingly gloomy, despite the many valiant attempts to argue otherwise.
The first (and most wishful) argument is that inflation, far from setting a 40-year record, is already falling: specifically, that a lag in reporting the data is obscuring the fact that inflation is lower than the government says. This is what Paul Krugman means when he criticizes “official measures of inflation.”
His core argument is twofold. One, the most worrying component in inflation is rents (which the Bureau of Labor Statistics uses to measure the cost of housing). Two, rents across the country have already peaked. There is reason to believe both those statements are true—but they have little to do with each other.
While housing costs are by far the largest component of the Consumer Price Index, they are not rising any faster than overall inflation. Krugman even posts a chart showing that median inflation has tracked housing inflation for years.
But the very definition of median is that there are as many data points above it as below. Housing isn’t some outlier that is distorting inflation; it is a central component that is being driven up by the same basic forces.
In fact, what makes the rise in housing costs so troubling is that, since only a fraction of tenants move every year, increases in the average rent paid have a significant lag. Even as rental listing prices fall, the rise over the last year has been so strong that many existing tenants will still face a hefty increase when their leases come up for renewal.
This means that housing costs as measured by the BLS lag behind rent indexes created for the industry. So even while rental listing prices are decreasing, they are still running far ahead of the BLS’s measure, and the BLS’s lag—which will bleed slowly into inflation figures over the coming quarters—is responsible for the difference.
Another argument is that declining home values will encourage homeowners to cut back on spending. This argument is more tenable in theory, but in practice it’s not likely to reduce inflation.
For the most part, home prices support (or undermine) consumer spending through something called mortgage equity withdrawal. That is the difference between the total amount of principal homeowners pay off each month and the total amount of new debt they take on through home-equity loans or cash-out refinancing.
Mortgage equity withdrawal was a factor in transmitting the housing crash of the mid-aughts to the larger economy. But the total value of withdrawals in 2006 was twice what it is today despite an economy that is 80% larger. The sudden drop in home prices also led lenders to rapidly tighten credit requirements, reducing the number of homeowners eligible for home-equity loans or cash-out refinancings.