Tag Archives: economy

Reporting

Inflation is Down. Why Aren’t Prices?

My article for the Kogod School of Business

Over the past several years, the economy has experienced unprecedented shifts driven by the pandemic, stimulus packages, and changing consumer behaviors. In July, inflation began to cool meaningfully after record increases during the previous two years. This year, the Consumer Price Index climbed 3 percent through June and less than 4 percent through May, after peaking at roughly 9 percent throughout the entire previous year in 2022. Unemployment remains historically low at 3.6 percent, due to robust hiring. Nonetheless, consumers continue to spend at a solid clip.  

There’s a lot to be said about living through a period with the highest inflation in four decades—and more than anything, it has been an ideal experimental setup for economists. While supply- and demand-related drivers frame the typical discussion of inflation, another idea that has gained attention is “greedflation.” Kogod finance professor David Stillerman offered his take on this phenomenon. 

“Inflation has been driven by both supply- and demand-side factors. During the pandemic, plant closures, supply-chain issues, and changes in labor-force participation put upward pressure on costs (and, therefore, prices),” Stillerman says. “This inflationary pressure was sustained or exacerbated by changes in demand for goods and services due to changing consumer preferences and pandemic-related fiscal policy. As supply chain issues resolve and the impact of interest rate hikes is felt, it is natural for inflation to decline.” 

Here’s how greedflation works:  

Inflation first rose because of factors like the pandemic and economic stimulus bills. But companies raised prices more than necessary to net higher profits because consumers no longer had a benchmark for what prices should be. When all prices are rising, consumers lose the sense of “reasonable” prices, creating room for companies to redefine that range. Dismissing greedflation as a “conspiracy theory” obscures the intricate relationships that characterize it.  

Greedflation could reflect corporate leverage and, in that sense, be more of a visible thumb on the scales if we believe corporations are supercharging inflation by increasing prices or not lowering them even as inflation declines.  

The greedflation argument is that higher firm markups (i.e., the ratio of price to marginal cost) have led to a rise in prices.  

“As someone who studies industrial organization, I take very seriously the idea that much of the time, markets are not perfectly competitive and that firms exercise their market power, raising prices and restricting output.”

However, the “greedflation” story suggests that a systematic change—unrelated to demand and marginal costs—occurred in the period following the onset of the pandemic that changed the way firms compete, allowing them to charge even higher prices (and earn higher markups). This could be, for example, that firms began colluding.  

The greedflation theory suggests that large companies can leverage their outsized market power to raise prices more than what should be possible in a truly competitive economy. But in some concentrated markets, that has not happened: hospitals are highly consolidated, yet healthcare prices have risen more slowly than overall inflation throughout the past year. 

In a greedflation scenario, we would expect that markets where prices increased the most also saw significant markup increases. But, recent empirical work and modeling find little relationship between industry-level changes in markups and price changes during the inflationary period. 

The conversation around “greedflation” underscores the intricacy of economic phenomena and the influence of corporate decisions in the broader economy. “In my view, this suggests that there is more going on than the ‘greedflation’ story implies,” says Stillerman. 

Reporting

Housing Markets and the Broader Economy

My article for the Kogod School of Business

While the question of whether we will face a recession in 2023 and how bad it may be (terms like “soft landing” and “recalibration” dominate the discourse) has been daunting, economists’ discussion about the housing market and how it is affected by the current monetary policy has not been quite as prominent. Professor Jeff Harris, Kogod’s Gary D. Cohn Goldman Sachs Chair in Finance, recently spoke with WJLA News on the topic.

The housing market, which accounts for nearly 18 percent of the US economy, has recently shown some signs of cooling, with home sales sinking and prices beginning to soften. Yet, this is hardly enough to bring purchase and sale prices to anything even closely approximating the pre-pandemic days, when the market became (artificially, perhaps) red hot, when home prices soared 45 percent from December 2019 to June 2022.

The Fed is attempting to slow inflation via a process that economists call “demand destruction.” By raising interest rates, the central bank makes it more expensive to borrow and spend. As the most interest-sensitive sector of the economy, housing is greatly affected.

Professor Harris was closely involved in the bank bailouts in 2008 as chief economist at the US Commodity Futures Trading Commission–his knowledge of the mortgage markets is vast and practical. “In 2008, and very much similarly now, it was hard to get a handle on how many mortgages are out there. There is not one database that tracks that. Yes, banks have records of when they issue mortgages, but data on prepayment is lacking—for example, this is for people who pay off their mortgage earlier. This is why then and now, it is hard for the central bank to get a clear view of what is happening in that sector of the economy and how the interest rate hikes are affecting it.”

Data from January 5 shows that mortgage rates rose to the highest level since the week that ended December 1, resuming from a slight decrease in December–the average rate on the 30-year fixed rate mortgage was 6.48 percent. It was 6.42 percent as of January 6, 2023, and 3.22 percent a year ago. Freddie Mac estimated that 15 million potential homebuyers have been priced out of the housing market because, for the first time in US history, the average 30-year fixed-rate mortgage rate has more than doubled in a year’s time.

The monthly costs for some home buyers are essentially double what they would have been a year ago. Combine that with the already high prices, and this will keep a lot of people out of the market.”

But another segment that should be discussed is buyers with variable-rate mortgages. “Because there is about a four to five-month period before buyers with variable rate mortgages begin paying the prevailing market interest, we might not have seen the largest impact of the rate hikes on those mortgages until now. These buyers will struggle with contending with these punishing new payments.” And because buyers who take variable interest rate loans are already not as financially stable as those who purchase on a fixed rate, this could be very worrying.

Buyers may not find significant relief anytime soon. Mortgage rates are expected to edge lower this year but remain at about 5 or 6 percent. While demand may have dampened, the supply of homes remains low. “The housing markets vary widely across the country, with some places experiencing mild downturns and some continuing to see price hikes,” says Harris.

You will see some softening in prices for homes that have been sitting on the market for two to three months, but prices are unlikely to return to pre-pandemic levels.”

Harris believes that, in many ways, the worst is over, so to speak–even if the Federal Reserve continues with rate increases, mortgage rates will likely decrease from current levels. Yet, housing affordability is likely to remain low.

Reporting

A Solid Foundation: Why has the housing market weathered the economic downturn so well?

My article for the Kogod School of Business

A wave of pandemic-induced uncertainty has thrown a pall over America’s economic performance, yet one sector remains a defiant shade of rose against a generally dark background. Why are home sales rebounding so quickly, with some locations reporting a return to the days of bidding wars? Is this a meaningful and lasting trend or simply a function of limited data from which to draw conclusions? “I think everyone in the industry is asking themselves what the new normal will be after such a cataclysmic event,” says Professor Steven Teitelbaum, who teaches Kogod’s Real Estate Development class and works in transit-oriented development and smart growth.

At the beginning of the pandemic in March, home sales fell by 8.5 percent as potential buyers lost their jobs, contended with economic uncertainty, or simply avoided moving due to health concerns. Existing home sales in April fell by almost 18 percent, but prices rose 7.4 percent compared to a year ago.

What could explain why basic supply-and-demand principles don’t seem to apply here? A huge drop in demand should put downward pressure on prices as the market sways in the buyers’ favor. But in this case, while demand dropped, so did supply. Sellers withdrew from the market for the same reasons that buyers did. New home listings fell dramatically after the stay-at-home orders, with estimates ranging from 29 percent to higher than 50 percent.

The drops in supply and demand were generally proportional to each other, but the lower number of transactions made it more difficult to analyze how prices moved in aggregate. “Data is so scarce that one blip sends things teetering toward one end or the other. It is hard to come by meaningful averages,” explains Teitelbaum.

Limited housing supply is likely to be a more prominent issue in certain areas. The pandemic has also affected new build construction. Professor Kim Luchtenberg, professor of finance and real estate, says, “The DC area will remain relatively sheltered from a real estate sector downturn because housing is in such limited supply. This will keep prices high, so buyers will not see much change.”

The number of homes listed for sale in the DC metro area dropped more than 37 percent compared to April 2019, resulting in the lowest inventory in the past 10 years.

A decrease in overall home sales has a number of effects. Home sales generate much spin-off economic activity. Local governments rely on revenue from deed transfer taxes to fund public services. Occupations like real estate agents, home inspectors, and other agents lose streams of income, as do support services like moving companies, furniture and appliance stores, landscapers, and maintenance technicians.

From a social perspective, people often buy homes when relocating for work, having children, getting married, or downsizing for retirement. An economic downtown that makes homeownership inaccessible may delay many of these milestones. For example, the Great Recession caused delayed household formation among young adults.

A much more grave concern is what will happen to the homeowners affected by the general economic downturn. “Foreclosures and mortgage defaults are sure to happen once the protection period ends,” says Luchtenberg. No one is sure how this will affect the real estate industry or the economy as a whole.

With so much turmoil in the stock markets and retail and hospitality real estate markets, plus general economic uncertainty, are investors attracted to the seemingly untouchable residential real estate sector? Luchtenberg and Teitelbaum concur that this trend is afoot, but in an unusual permutation—investment in single-family home rentals. This was the case immediately following the 2008 collapse, and currently, these kinds of rentals are one of the fastest-growing investment vehicles both for large corporations and individual investors. “The second-best option to owning a home is renting a single-family unit. Investors see that,” says Teitelbaum. Luchtenberg is currently writing a research paper on this phenomenon as well.

While understanding the “new normal” seems like an impossible proposition, in the DC area, at least, the old normal of a robust residential real estate market remains.