Would changing the Fed’s inflation target help people afford homes?
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Would changing the Fed’s inflation target help people afford homes?
This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.
Listener Niraj Parikh from Marlton, New Jersey, asks:
Is 2% inflation truly good for the average American?
The Federal Reserve tries to keep inflation at a steady 2% rate. Some employers use inflation measures like the consumer price index to keep wages in line with inflation. Parikh wants to know if the inflation target were higher, would that lead to higher wages and allow more Americans to buy homes?
The annual rate of inflation was 2.6% last month, according to the CPI. It’s a slight uptick from the 2.4% rate in September, but much lower than when inflation hit a 40-year peak of 9.1% in June 2022.
The median sales price for a home in October was $435,000, while the average 30-year mortgage rate is 6.78%. Early in the COVID-19 pandemic, the housing market became more competitive and prices rose due to factors such as low interest rates and an increase in remote work.
The CPI doesn’t factor in housing prices directly, but it does look at owners’ equivalent rent, which accounts for 24% of the index. Marketplace in 2022 described OER as “the hypothetical rent homeowners would pay if they weren’t homeowners, or the hypothetical rent they forgo by not renting out their property.” The CPI also looks at regular rent and expenditures on lodging away from home, like hotels. In total, shelter makes up about a third of the CPI.
The personal consumption expenditures price index, the Fed’s preferred inflation measure, also takes into account shelter. But it only makes up about one-seventh of the PCE.
So should 2% inflation be the Fed’s goal?
A higher target could mean wage increases if employers make cost-of-living adjustments. And higher earnings would theoretically help Americans afford a home. But those same people would have to grapple with higher prices overall, as consumers did early in the pandemic.
“Once you start to get 3% to 4% [inflation target], people really feel these costs,” said Connel Fullenkamp, an economics professor at Duke University. “And I don’t think people really want to live with that over long periods of time.”
Rising wages could lead to a wage-price spiral, in which higher pay leads companies to raise prices for their products or services. Workers, in turn, might ask for higher wages to keep up with those prices.
From January 2021 through the second quarter of this year, prices rose 20%, but wages fell behind, rising only 17.4%, according to Bankrate.
That 2% target gives us price stability, Fullenkamp said, which is part of the Fed’s dual mandate.
“There’s slight upward pressure on prices, which is actually good for the economy, but not too much,” he explained.
You don’t want inflation too low because when lots of prices fall at once, consumers may stop spending.
“If we think something will be cheaper tomorrow, we don’t buy it today,” Carl Tannenbaum, chief economist at Northern Trust, told Marketplace earlier this year.
And if the Fed says it’s going to allow inflation to go up to 4%, then mortgage rates will rise, said Michael Klein, an economics professor at The Fletcher School at Tufts University and executive editor at Econofact.
“When people lend money, they want to cover themselves for what they expect inflation to be in the future,” Klein explained.
How can you keep prices down while ensuring that wages go up?
“The magical sauce is productivity,” Fullenkamp said. “Because if people are more productive, that means they’re more efficient. You’ve got the same number of workers. You’re producing more stuff. That’s good for profits. You can raise wages comfortably without stoking inflation.”
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