I often argue that current NGDP depends heavily on future expected NGDP. That’s also a prediction of modern New Keynesian macro models. However, this generalization is less true during the current Covid pandemic, as current output is artificially depressed by social distancing.
But even social distancing cannot stop asset markets from looking ahead. The current price of assets such as houses is roughly equal to the 12-month future expected price (a bit lower due to trend inflation.)
Consider the recent boom in house prices, occurring despite a severe recession with 10 million fewer jobs than a year ago:
Home prices surged the most on the record in the third quarter, according to a report Tuesday from the Federal Housing Finance Agency.
With record-low mortgage rates fueling demand for housing, prices jumped 3.1% compared to the prior quarter. That was the biggest gain in records dating to 1991, according to FHFA.
Compared to 2019, prices were up 7.8% in the three months through September, the biggest jump since 2006.
What’s going on here? I’d point to three factors:
1. An expectation that the Covid pandemic will be over within 12 months, probably even sooner, due to the many vaccines being developed.
2. A long run downward trend in interest rates that began in the early 1980s and shows no sign of ending.
3. Increasingly strict land use rules, motivated by “NIMBY” attitudes among the public.
Because the first point is fairly obvious, let me focus on the other two. We don’t know all the reasons why interest rates are trending lower, although demographics are probably one factor. Population growth in slowing, and interest rates fell first in places like Japan, where population growth slowed earlier than in the US.
(I suspect that our economy’s shift in emphasis from building things to creating ideas also plays a role.)
But the second reason (lower interest rates) would not normally be enough, for “never reason from a price change” reasons. In a well functioning economy, higher housing prices should lead to more new construction. Anticipation of these increases in production would limit the price increase. That used to happen in the mid-20th century, when it was fairly easy to build houses in America. In recent decades, however, it’s become harder and harder to build new homes, in more and more cities. Thus we will increasingly resemble places like the UK, Hong Kong, Canada, Australia and New Zealand, where house prices have reached a permanently high plateau (in real terms) due to strict building limits.
There are also lessons for monetary policy. Just as expectations of high post-pandemic house prices create high house prices today, expansionary monetary policy that boosts expected future NGDP can boost NGDP right now. Indeed this is basically the argument for average inflation targeting–create future inflation expectations to raise current inflation. Bullish expectations can’t work miracles (for output) when a real shock like Covid causes people to hunker down, but in a normal recession the expectations channels is by far the most important part of stabilization policy–Nick Rowe likes to say it’s about 99% of monetary policy.
READER COMMENTS
Alan Goldhammer
Nov 24 2020 at 2:42pm
#4 – flight from cities to suburbs as the pandemic shut down office buildings and city dwellers wanted more open air living environments (this has been well documented). In our suburban Maryland neighborhood, existing homes are selling the day they go on the market.
robc
Nov 24 2020 at 3:00pm
A house in my neighborhood literally had an offer in under 5 minutes from the listing being active. Suburbs outside Charleston, SC — it is probably 50% fleeing NY/NJ residents (mostly fleeing taxes, not coronavirus).
MarkW
Nov 24 2020 at 3:59pm
Yes. And the flight from the cities enabled by remote work may blunt the impact of Scott’s factor #3. If you don’t need to commute to the office, why would you even have to stay in the metro area? Or the state? If some of those SV tech folks start permanently working from, say, Las Vegas, Phoenix, Denver, Salt Lake City or the PNW, it’s still an easy flight in for an occasional meeting, but none of those folks would be subject to CA income taxes. Highly paid and location independent workers may turn out to be a real wild-card. Did anybody see Iceland’s latest gambit to attract folks like that? This could get interesting.
Dylan
Nov 24 2020 at 4:43pm
My senior thesis was on just this idea, what would the impact of highly compensated and location independent workers do to the demographic makeup of the country. We predicted net migration away from big metropolitan areas and to areas with high “natural amenity scores.” Looks like we might have been exactly right, just two decades and one pandemic early.
MarkW
Nov 24 2020 at 5:13pm
Both high ‘natural amenity scores’ and also — I don’t know quite what to call it, but maybe ‘urban livability scores’. Places that offer urban amenities but with low crime/taxes/levels of disorder. Of course, many of these places offer both (e.g. Asheville, NC).
Mark Z
Nov 24 2020 at 9:17pm
Yeah was gonna say the same thing. Home prices may be rising but rent levels are collapsing in many big cities including mine.
Scott Sumner
Nov 24 2020 at 10:52pm
Everyone, I think people missed the point of the post. I’m arguing that the pandemic has nothing to with the high prices, as the pandemic will be over in 6 months and the prices will still be high.
john hare
Nov 25 2020 at 4:02am
Kinda/sorta betting that certain segments of the housing market prices collapse in the next six months. The somewhat cheaper rental houses that have been hit with the various eviction moratoriums and with certain renters financially hit by the various problems this year should see many of those houses on the market. My employees (all both of them) live in houses purchased cheap from disgruntled landlords in the past. Cheap on money in the $30K range, but requiring a lot of elbow grease to rehab. Their houses are paid off and they both have rental property producing income. The income property bought the same way.
It is well known that some renters will use any excuse to not pay and will trash a place, often stealing the appliances on the way out. My fiancé and I hope to pick one up from a disgruntled landlord early next year in similar circumstances. Also, developers are building and developing everything they can locally as fast as they can and at some point there will be a dip.
Alternate is we will build one ourselves if wrong. I’m in construction and my partner is a general contractor.
Todd Ramsey
Nov 25 2020 at 9:36am
#4. People put their unwanted excess money balances, created by Federal stimulus programs, into assets like houses and equities.
Michael Pettengill
Nov 26 2020 at 2:48pm
Why have conservative GOP governments implemented such clampdowns on land use, especially when so much vacant land exists in their jurisdictions?
As a boomer, I grew up with constant tax and spend to fund building roads, water, sewer, schools, public transit, to open up new land for new businesses and large single family housing. Towns doubled in population and doubled again before I finished primary school. That was in Indiana which since the 70s has seen many of those towns shrink.
Why is it that all the bad economic policy leftist cities has so much demand for real estate that asset prices rise much faster than the costs of building new real estate?
Zoning, etc, do not explain the clear market failure that is signaled by such high Fed driven asset price inflation.
Ted Durant
Nov 27 2020 at 11:17am
One of my favorite interview questions (hiring for predictive modeling analysts in mortgage insurance) was, “Explain the connection between interest rates and home prices.” It has always been a mystery to me that people highly trained and experienced in economics don’t understand the connection at all. It’s really quite simple in fundamentals: interest rates are the price of money, and money and houses are complementary goods. Most people buying a house also need to buy money in order to buy the house, and most people who own houses have the ability to buy money at a reduced price. This is further complicated, however, by the fact that houses (depreciating long-life consumer goods) sit on land (generally appreciating assets), so “houses” are really bundles of consumption and investment. Interest rates, as the price of money over time, affect both consumption preference (lower interest rates, ceteris paribus, shift consumption to the present from the future) and investment value (lower interest rates, i.e. lower capitalization rates, ceteris paribus, lead to increased asset values).
Ceteris isn’t usually paribus, of course, and 2020 is a unique set of circumstances. What is going on in housing markets is a combination of historically low mortgage interest rates with: 1) (as noted) a marked shift in housing preferences away from urban cores and toward larger living spaces, a trend which has been accelerated by remote work driven by COVID-19; and 2) the demographics of the largest segment of the population hitting peak home buying age as the second-largest segment of the population is hitting retirement age. It is important also to recognize that, so far, the economic impact of pandemic-induced shutdowns is extraordinarily asymmetric, with income disruption falling most heavily on people who were not likely to be in the home purchase market.
Some property markets are tanking, others are inflating rapidly. As I like to say, the Newtonian physics of housing are pretty simple: fast-changing demand, slow-changing supply. Housing markets are rarely, if ever, in equilibrium. Our national “housing policy” is entirely focused on making borrowing cheaper, which is pretty much the equivalent of spraying liquid oxygen on a fire when supply is constrained.
So, back to expectations. The change in housing preferences away from urban cores and to larger living spaces suggests that, for a significant part of the population, the expectation is that remote work is here to stay. Anecdotally, I have confirmed this expectation in many conversations. I would also note, anecdotally, most people I talk to (outside of macro economists) expect interest rates to stay low for a long time. People are adjusting their consumption and investment decisions accordingly.
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