If you want to know what stagflation looks like, check out the housing market. The conditions that existed during the 1970's — high inflation and stagnant output — are happening already in this segment of the U.S. economy, illustrating the challenges ahead for consumers, industry players and the Federal Reserve.
Though homebuilders continue to expand construction in response to elevated demand, the number of homes actually being completed has been stagnant because of persistent supply chain problems. This stagflation is a headache for homebuilders and homebuyers, but it's a benefit for many existing homeowners — and therein lies the Fed’s predicament as it seeks to lower inflation.
U.S. home prices rose by 18.8% in 2021, according to the Case-Shiller U.S. National home Price Index. Yet real residential fixed investment fell in the second and third quarter of 2021 and was essentially unchanged in the fourth quarter. Homebuilders are trying to build more homes, but the housing supply chain still hasn’t been able to increase production to match. On a seasonally-adjusted basis, completions of single-family homes have been unchanged since August 2018.
There are two ways to address this stagflation. The good way would be to improve the supply of resources like garage doors, cabinets and windows that are holding back the homebuilding market. That's something policymakers don't really have the tools to address, at least in the short run. The second way would be to restrict credit or raise mortgage rates high enough to reduce home-buying demand, thus reining in home prices.
But that's a challenge too. The inventory of new and existing homes for sale is at a record low. And as Bill McBride of the Calculated Risk blog has noted, we're in the home-buying sweet spot, from an age perspective, for the large Millennial generation, ensuring strong demographic demand for the next several years. Raising interest rates high enough to put a dent in the housing market would throw the rest of the U.S. economy into recession first. We don't have, or aren't willing to use, policy tools that would cool off housing demand while leaving the rest of the economy unaffected. At the peak of the credit bubble the housing market was the most fragile part of the U.S. economy. Today it's arguably the most robust, from a demand standpoint.
