My brother-in-law remarked that "the fed is overdue to raise rates". My reply: asset prices don't matter to ordinary people.
You already know this, but the Fed's mandate is "price stability and full employment". Full employment is going great -- the job market is tight, low-end labor is seeing lots of wage growth, everyone who wants a job is getting one.
Price stability was also fine until about 6 months ago.
The thing I keep coming back to, is how incredibly little asset prices really matter, in the larger scheme of things. What does matter is things like employment, the price of milk, and whether people have a roof over their heads (rental affordability).
In the larger sense, the fed's hands are tied, unless their legal mandate is amended to include "not creating asset bubbles". The distributive and stability effects of today's monetary policy might be the longest-lasting intellectual shift to come out of all this.
Home values matter enormously to people. So does the value of their 401k, especially those aged 50+
Sal is an average American. Sal can afford $1500/mo for a mortgage, regardless of interest rates.
Today, Sal can get a 3% rate, meaning they can afford a $440k mortgage (with 20% down payment).
If interest rates rise to 6%, Sal can now only afford a $310k mortgage for that same $1500/mo.
If Sal were the only person who had this problem, then Sal would have to settle for a cheaper house than average. But if 90%+ of buyers are in the same situation, then the housing supply will be overpriced compared to what the market is able to pay.
This drives the prices way down, and it would eventually settle to the price that the market can bear, which might be slightly more than the $310k, but probably not too much.
If interest rates are 15% like they were in the early 80s, Sal will be expecting salary increases of >15% a year to keep up, so that $1500/mo won't stay that way for long.
Can you provide some data on this assertion? I would be surprised to learn that the majority of ordinary people (assuming you mean something like 'net worth < $1MM USD') do not care about housing costs and car costs, which are both assets.
Also, speaking broadly, I don't think the economics profession really understands the connection between house prices and rents. It's a complex topic with a lot of conflicting information. I definitely wouldn't take it as an article of faith that more expensive housing necessarily implies higher rents. There are all kinds of complex subsidies like mortgage interest deductions, factors like credit availability, short-term fluctuations in material and labor prices, etc that make a straight-through 1:1 correlation too clean.
As a general comment, it helps to disaggregate when thinking about huge topics like rental inflation. Rent is growing fast in western/mountain markets (e.g. Idaho) and places like Miami, while hardly budging in places like Cleveland or St. Louis. I'm sorry not to have citations on a lot of this, it mostly comes from firsthand experience and a lot of reading -- I read the economist cover-to-cover every week, manage 12 rental units, and talk to friends and family spread across the US (Seattle, DC, Chicago, Indiana, etc) almost every week.
Following the references and links I ended up reading this: https://www.federalreserve.gov/publications/files/scf20.pdf, on the top of page 6 there is an interesting tidbit:
> One liability of using the median as a descriptive device is that medians are not additive—that is, the sum of the medians of two items for the same population is not generally equal to the median of the sum (for example, median assets minus median liabilities will generally not equal median net worth). In contrast, means for a common population are additive.
Still, 79k for adults, inclusive of retirement accounts, home equity, etc. really isn't much.
They do. A large percentage of the population has 401Ks, and many public sector pension plans have equity components. Housing prices are also assets, and inflation in that sector has priced out many people from affording homes, despite low financing costs.
> Full employment is going great -- the job market is tight
We are nowhere close to full employment. We're 3M jobs lower than pre-COVID in the U.S [1], and according to Keynesians, Monetarists, Monetary Keynesians, or whatever hybrid form of wishy washy economics that has used the Phillips curve as policy guidance, this inflation should not happen.
> In the larger sense, the fed's hands are tied, unless their legal mandate is amended to include "not creating asset bubbles"
The Fed's "dual mandate" presumes that (based upon the Phillips curve) there is a sweet spot between full employment and inflation. The correlation is entirely, completely broken [2].
[1] https://fred.stlouisfed.org/series/PAYEMS [2] https://www.nber.org/digest/sep19/phillips-curve-still-usefu...
I won't agree or disagree with your comment, I will just say that the parent poster's comments are all unsupported by data. Clearly, we had a realm only two years ago with (1) millions of people more in the labor market, (2) inflation at 1/4 of what it is now.
We also have been told for two years that inflation like this was impossible, despite editorial after editorial from non-Keynesians saying that we should expect high inflation and supply shocks. This is because supply shocks inevitably happen when capital is mispriced and aggregate demand is forced via government spending. The notoriously smooth supply chains (ha ha) of Soviet command economies was not a historical aberration generated via inflation.
So I won't be listening to the people who have been wrong for two years. Their economic model is wrong, and we can expect their predictions to look like the "Cloud of Points" section of the Phillips curve from the 1970s [1].
[1] https://www.stlouisfed.org/open-vault/2020/january/what-is-p...
The FRED numbers saying who is seeking work is the data and far supersedes the source you're not even naming. I'm guessing you're upset because a certain % of the population isn't in the workforce. Well, that's not what full employment is. Random commentors are on the internet don't decide the "full employment" really is. The term full employment applies to those people that are seeking work and can't find it. Unemployment is quite low.
> We also have been told for two years that inflation like this was impossible
"Inflation like this". I'm amazed that we've returned to inflation levels that were the norm for many, many decades during times of relative prosperity, and inflationistas think that they've suddenly been vindicated. No, I'm sorry, 7% isn't the Zimbabwe Republic inflation you've predicted for decades ad nauseum, and no, we've not suddenly adopted a Soviet command economy.
Not very strong evidence but I think it would support the idea that more families are taking care of children in the household economy rather than the cash economy if it is recovering less quickly.
It's massive, some people more than $100 per month increase.
The waves of homelessness and people living out of their cars starts in a few months.
https://www.apartmentlist.com/research/metro-rent-changes-18...
Last year I looked at renting a similar 2BR apartment in the new place, but prices jumped from 1300/month to 1650/month in like 6 months. So just went ahead and bought a house.
It'll work out in a year or so, or we'll get hit with hyperinflation.
Rental affordability is 100% correlated to asset pricing.
Simply put it's tied to opex + cost of capital. And is opportunity costed against other investments -- but keep in mind real estate has high exit costs (realtor). So you'd have to think you can do much better on another investment to sell (and drive the asset price down) for it to make any sense.
The insight is that the cost of capital is roughly fixed at the time of purchase. If someone bought a place in 1970 they can price bid down to nearly nothing because that's their operating cost and the purchase price is only a fraction of landlords who bought recently.
Supply and demand create the conditions where landlords either compete on price, choose to sell, or potentially declare bankruptcy.
Asset pricing is what's correlated to rental affordability. If the tenant class, in general, can't afford rent increases, rent won't increase, and real estate asset prices will stop growing, all other things being equal. Obviously, if money becomes cheaper for landlords, then they will borrow more of it to buy the same properties. But this does not give them any more power to unilaterally set rents.
But all in all, the tail does not wag this dog.
It's not, though.
In a very simplified toy model, maybe there should be a direct 1:1 link, but empirically in reality there isn't even close.
their real mandate is: "protect the banks"
at this point, that may be changing to "protect their necks"
rock and hard place, we'll see what happens
No that's literally their mandate.
The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."
many such cases
Lots of Fed criticism to go around for everyone’s enjoyment.
It's like saying you think the USPS is lying that they have the mandate to deliver letters.
> Please respond to the strongest plausible interpretation of what someone says, not a weaker one that's easier to criticize. Assume good faith.
The GP is saying that the Fed has other objectives than the ones that are formally stated.
Is it? I thought we still have a labor shortage and the unemployment metric is skewed because it doesn't tell the full story of people who just left the labor market.
Don't you love it how banks are not raising their interest rates on savings accounts? I remember in 2007 I was getting 4% on my savings accounts. There's nowhere to park your money and earn a return even approaching inflation. Why not just front-load your future purchases and further drive inflation?
That's one reason why, given the insane fiscal and monetary policy of the last two decades, we really haven't seen hyperinflation yet (and, in fact, briefly saw deflation.)
It's an unorthodox take, admittedly, but Steve Keen is a good economist to read on the topic.
There's a lot of money and credit is amplifying it
No, it doesn't. Net present value (NPV) of future cashflows is defined [1] as the sum over time periods of the ratio of the cashflow in the k-th period to one plus the discount rate raised to the power of k:
NPV = sum_k r_k / (1 + i)^k
NPV = sum_k r_k
right, so the net present value of, say, a rental unit (or any ongoing productive investment) is the sum of an infinite number of payments which, if my math is correct here, is infinity (regardless of the recurring payment amount)
of course there is a risk discount as well, which, as I mentioned on a sibling comment, has been removed in many cases by the fed backstopping a lot of investments
there's a reason we don't see actual infinite prices, after all
my general point is that as interest rates get very low, npv gets really whippy and I expect that to be what we see going forward
just a guess and I'm not an economist, although experience suggests that's a point in my favor
Perhaps we should dispose with all the math though as it should be intuitively clear that if we discount future cashflows at zero rate, i.e. if we do not discount future cashflows, then their present value should be equal to the future value. After all, discounting just means that you value future money less than today's money. If you don't discount, you value both the same, so whatever formula for discounting you use it must be true that plugging in zero rate yields NPV equal to the sum of future cashflows.
Agreed about risk discount. Perhaps what you mean by "whippy" is that as the risk-free interest rate goes to zero NPV becomes increasingly sensitive to the risk discount.
[1]: https://en.wikipedia.org/wiki/Geometric_series
[2]: See [1]. Also, as an example, recall that 1+1/2+1/4+1/8+...=2.
The fed basically controls the very short end of the curve. The 30 year rate is above 2 (it briefly touched around 1.3 or something during the start of the covid panic). No one is/was discounting cashflows 10 years into the future at 0 so "all cash flows" didn't have infinite net present value.
You'll find as you reduce the nominal cashflows by the inflation rate to arrive at real cashflows.... they stop being a cashflow pretty quickly.
Maybe I'm an idiot, but if so, I'm not alone. Multiple major investment firms are recommending this to their clients.
Anyway, I gotta go count my Krugerrands.
Put aside finance theory for a second - does it make sense that, even in theory, my rental house earning $100 per month more than the cost to upkeep it, is worth infinity? Of course not.
but not much of one when the fed has backstopped everything that matters
another policy error, in my uniformed opinion
If anything I'd say this exercise shows the limits of Federal Reserve power. Without the tight labor market of the pandemic, low interest rates simply raised asset prices. We should take the lesson that the fed should not be solely responsible for driving the economy.
This is only true for cash flows discounted by the risk-free rate. The discount rate of risk assets comes from the risk-free rate with a risk premium added on top (probably 6% or so today for the average blue chip equity).
Classic HN 'Confidence = knowledge' comment.
I do believe that even stocks, in the long run, will be discounted against a general opportunity cost and that really low interest rates make small movements really significant in that regard
we'll see
https://learn.robinhood.com/articles/5FDKWbZjnNFHfEPYRNhLtE/...
I am extraordinarily skeptical of essentially the whole comment except this. Economies are very complicated systems composed of many non-rational actors. All economics is voodoo IMHO. It's akin to try to predict the fluctuations in current on a motherboard's bus without having any conception of what program is running. Total guesswork on top of a system more complicated than human understanding.
We want to understand economies in terms of pipes and pressure and the complexity-equivalent of simple machines, when in reality the future is going to be dominated by black swans: crazy things like cryptocurrencies, cyberattacks, once-in-a-millenium climate/weather events, political revolutions, and fads.
Chaos, indeed!
You and me both!
>I expect a lot of chaos with the economy whipping between inflation and deflation over the next few years as the Fed tries to ride the tiger.
So you expect inflation to remain @ the 2-ish percent target but with extreme volatility?
It's an interesting theory, why do you think that?
We've also seen that interest rate cuts amd QE are very weak at stimulating inflation, and very strong at stimulating asset values.
I'm coming around to the view that UBI should be used to fight deflation, and interest rates to fight inflation.
https://www.investopedia.com/terms/n/npv.asp
when the discount rate is 0, the NPV is simply the sum of all payments in the series, so an infinite series of payments (e.g. rental income) is worth infinity
in reality, bad stuff happens: building burn down, renters leave, etc. so the right thing to do is to discount the payment stream by some risk function, particular far off payments
I don't think this is meant to be a balance act or achieving that is possible at this point.
I expect a lot of chaos with the economy whipping between inflation and deflation over the next few years as the Fed tries to ride the tiger.
It's a good reason to never let rates get this low in the first place. From zero, any increase is an infinite increase in interest rates, and a corresponding crater of NPVs.
Welcome to the long run, folks. At least Keynes is dead, so, good for him, I guess.