Inflation slowed more than expected in July, the result of a dip in gas and energy prices. But soaring housing costs continue to weigh heavily on family budgets. Rents and home purchase prices are up – 17% and 20% respectively – from last year. It seems as if every day there is yet another news story highlighting how so many families are suffering under crushing housing costs.
These costs make up one-third of the Consumer Price Index, meaning they account for a big part of the inflation dilemma. For a little perspective: The shelter component of the CPI increased 0.5% in July, rose 5.7% over the last year, and accounted for about 40% of the total increase in all items other than food and energy.
CPI changes also typically lag real-time changes in housing costs, so we can expect the shelter to loom large in future CPI calculations even if rent growth may be slowing down, as some have suggested.
Classic supply and demand mismatch
At the root of high and rising housing costs is the severe shortage of affordable homes both for rent and sale. What we are witnessing is a classic supply-demand mismatch: there are simply not enough homes, particularly those that are affordable to low- and middle-income households. While estimates vary, most analysts agree we have underbuilt housing of all types by millions of homes over the past 20 years.
Economists are beginning to highlight the importance of increasing the housing supply to help reduce inflation. As Mark Zandi, Chief Economist at Moody’s Analytics explained to the Washington Post: “No matter what happens to price across most goods, inflation will remain high as long as the cost of housing continues to rise so quickly.” In a more recent tweet, Zandi adds: “Driving [strong rent growth] is a severe shortage of affordable homes, which has been long in the making, and won’t be resolved quickly.”
Jason Thomas, the former economic advisor to President George W. Bush, concurs, saying that high inflation can be attributed to the country’s “structural shortfall” when it comes to housing. He notes, “You could really see core inflation down close to target by year-end were it not for shelter, were [it] not for primary rents…. When you look at the data in terms of cumulative housing starts it looks to be somewhere between one-and-a-half and 4 million short of what is actually necessary.”
Closing the housing supply gap will not happen overnight because it has taken some time to get where we are today. The construction industry has yet to fully recover from the 2008 financial crisis when it lost a big segment of its skilled construction workforce. Pandemic-related supply chain snags have impacted the prices of key construction inputs like lumber, steel, and copper. Add to this mix significant regulatory compliance costs, as well as local zoning and land use requirements that restrict the type of housing that can be built, and we have a recipe for a constrained housing supply.
Rising interest rates
Ironically, rising interest rates, the result of the Federal Reserve’s tightening of monetary policy to combat inflation, are also affecting the homebuilding industry. Residential construction statistics from July 2022 show construction of single-family homes is the weakest since the onset of the pandemic and construction of multifamily dwellings has fallen as well.
The good news
While these facts should give us pause, the good news is there are many policy options that can be tapped now to increase housing supply and improve housing affordability.
At the local level, city governments can:
At the state level, officials can:
- streamline the application process to obtain affordable-housing financing,
- utilize tax incentives and other measures to spur the conversion of underutilized commercial space to housing, and
- work with industry and academic institutions to support innovations in home construction that can reduce costs.
Federal policymakers, in turn, should:
- expand and strengthen the Low-Income Housing Tax Credit program, a vital source of financing for affordable rental homes,
- pass the Neighborhood Homes Investment Act, which would encourage private investment in entry-level homes for sale in distressed communities,
- create federal incentives to help communities implement zoning reforms, and
- strengthen efforts to preserve our existing affordable housing stock.
The affordable housing crisis is a national problem requiring a national response, one that is not limited just to Washington, DC, state capitals, or city halls. Fortunately, solutions abound – some big, some small, but all meaningful.
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