New Zealand Has a Lesson for the Fed on House Prices and Inflation

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In New Zealand, where sensible policies brought Covid-19 under control, monetary policy will now take into account soaring house prices—something the Federal Reserve refuses to do in the U.S.

Soaring house prices don’t get counted directly in the consumer-price index, which uses a convoluted system of “imputed rents” to figure the cost of shelter. That accounts for almost one-quarter of the CPI, the most widely followed U.S. inflation gauge. But as discussed previously in this column, this understates the steep rise in housing costs

In the second day of his semiannual Congressional testimony, Fed Chair Jerome Powell was asked Wednesday about that subject by Rep. French Hill, R-Ark. By bringing up a topic germane to the economy and monetary policy, he offered a welcome respite from the typical speechifying from his fellow inquisitors on the House Financial Services Committee and their counterparts on the Senate Banking Committee the day before.

Hill noted that, along with the rally in commodities, residential real estate has been soaring. But, he continued, the “imputed rent” measure used by the Bureau of Labor Statistics is up about 3% (presumably at an annual rate).

“I’ve never bought it, I don’t know if you’ve ever bought it,” he continued. “But if you look at the price of existing homes, I think they’re up 12 [%], new home prices are up 8%. Is that one that you focus, that imputed residential rent, since it is about 25% of the CPI, how do you look at that issue?”

Like any good central banker, Powell wanted it both ways. While emphasizing stable prices are half of the Fed’s mandate (along with maximum employment), he sought to explain away surging house prices, which Hill understated. Median sales prices of existing homes were up 14.1% in January from a year earlier, versus 12.6% in December.

Powell reiterated the surge was temporary, owing in part to the well-known rush to buy single-family houses to escape urban lockdowns and to have space to work at home. He also mentioned in passing that low interest rates contributed to the housing boom.

But inflation expectations remain well anchored, the Fed chief continued, and that’s what’s important. And he suggested house prices will level off.

Joseph Carson, the former chief economist at AllianceBernstein, has been a persistent critic of the undercounting of housing costs in inflation measures. In his latest LinkedIn blog post, he points out that the BLS data show rents paid for primary residences exceeded the imputed rents of owner-occupied houses by a cumulative 20% over the past two decades.

More houses are being rented, and at higher rents, write Strategas economists Don Rissmiller and Erica Halie Comp. That is not surprising given the success of companies such as

Invitation Homes

(ticker: INVH), which have consolidated the fragmented business of renting single-family homes.

At the same time, the exodus from apartments to houses has cut rents, which depresses the CPI. It has also led to a surge in prices of single-family homes, which don’t get counted directly in the inflation gauge.

In New Zealand, however, they are seeing through this nonsense. Finance Minister Grant Robertson on Thursday directed the Reserve Bank to take into consideration the impact on housing in setting its monetary and financial policy, Bloomberg reported. The government aims for “more sustainable housing prices,” to dampen investor demand for existing homes to improve affordability for first-time buyers.

In the U.S., a clear effect of the Fed’s super-stimulative policies has been a house-price boom that has shut out many first-time buyers who get outbid by better-heeled competitors. Not only has the central bank pushed its short-term interest rate to near zero, it continues to purchase $120 billion of securities a month, including $40 billion of agency mortgage-backed securities.

Perhaps the Fed could shift its purchases from mortgages to all Treasuries to suppress the rise in longer-term Treasury yields, the Strategas economists write in a research note. In effect, the central bank could declare “mission accomplished” for the booming housing market, they suggest.

For now, however, the Powell Fed doesn’t see that soaring U.S. house prices constitute inflation or that their policies are behind it. In New Zealand, my Kiwi cousins know better.

Write to Randall W. Forsyth at randall.forsyth@barrons.com