Worried about inflation? Then build more apartments
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WASHINGTON (MarketWatch) - It's not often that the daily flow of economic data so perfectly aligns with the economic law of supply and demand.
Recall for a moment what the law tells us: When effective demand for a good or service exceeds the supply, prices will rise, relative to other goods and services. In reaction to those higher prices, more of that good or service will be produced. And that extra supply will tend to stabilize prices.
It's a constant dynamic in a market economy.
Home building is particularly depressed today. After the bubble of the past decade, home prices plunged, sending a strong signal to stop building housing. Housing starts plummeted by about 75% to an annual rate of about 500,000 by early 2009.
Slowly, the overstock of new houses has been worked down and demand for housing has increased. If supply has been reduced and demand is rising, what would you expect to happen to prices?
Correct! The price of buying or renting a home has increased. According to a report released today by the Bureau of Labor Statistics, the cost of shelter - what the government calls housing - increased in July by 0.3% for the sixth straight month. Over the past year, shelter prices are up 2.9%, compared with a 2.3% increase a year earlier.
Although most people think of higher food or gas prices when they think about inflation, the inflation that we've recently experienced in the U.S. is more of a story about shelter prices, in part because shelter is a much bigger item in the consumer's budget than food or gas. But, perhaps surprisingly, shelter costs are also rising faster than either food or energy costs are.
The increase in shelter prices has accounted for all of the acceleration in the consumer price index over the past year. Excluding shelter, the CPI has actually slowed over the past year from a 1.8% year-over-year increase in July 2013 to 1.6% in July 2014.
You may have heard that the Federal Reserve isn't overly concerned about inflation, and now we know one of the reasons: The Fed wants shelter prices to rise (temporarily) because higher housing prices will encourage more construction, which remains the most depressed part of the economy. (Higher housing prices would also help repair the balance sheets of indebted homeowners, which is another goal of economic policy.)
By coincidence, the Census Bureau reported today that new construction of housing units rose by nearly 16% in July to an annual rate of 1.09 million. That's a direct response by builders to the steady increase in shelter costs.
Encouragingly, the supply of apartment buildings and condos, in particular, has been rising robustly. Whether it's because they can't qualify for a mortgage, or because many young people prefer to live in inner cities rather than suburbs, the demand for apartments is surging. We know this because rents are rising rapidly.
New construction of multi-unit apartment and condo buildings has risen to an average annual rate of 372,000 over the past four months. That's the fastest pace of building in 25 years.
The CPI and housing starts? It's all about supply and demand.
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