Strength in the US housing market may mean the Federal Reserve needs to slow other sectors of the economy more to stamp out inflation, Richmond Fed President Tom Barkin suggested in an interview with the Odd Lots podcast.
In the past, housing was a critical part of the transmission mechanism from tighter monetary policy to a slowdown in the economy because it’s highly interest-sensitive, and it accounts for a sizable portion of swings in economic activity.
But the pandemic led to a “secular change” in the way people think about housing, Barkin says, which has helped keep a floor under home prices and construction activity even as the average 30-year mortgage rate has surged to 22-year highs above 7%. With the Fed broadly seeking to bring economy-wide supply and demand into balance, that means sectors apart from housing may need to slow more.
“To get into balance, you can get there with lots of different goods and services pricing in very different ways. You don’t just have to get one element in shape. Now, housing’s a big part of the economy, and so if rents come into line and housing comes into line, that would be useful,” the Richmond Fed chief said.
“But relative prices move all the time. And if what we’ve had is a secular shift toward more demand for housing, that might mean somewhat less lessening of housing prices and somewhat more lessening of another set of prices.”
Last year, Fed Chair Jerome Powell talked about the need for a “reset” in an overheated housing market, and a desire to “get back to a place where supply and demand are back together and where inflation is down low again, and mortgage rates are low again.”
Some 15 months later, US house prices have hardly blinked in the face of higher interest rates, with the S&P CoreLogic Case-Shiller Index climbing to a new record in July following a brief earlier decline.
“There’s been a secular change in the priority people place on housing,” Barkin said. “If you're spending five days a week at home, three days a week at home, seven days a week at home, your house matters a lot more, your office matters more, your patio matters more, your furniture matters more. And we saw that during Covid.”
Fed officials more generally are still trying to understand the impact of the highest interest rates in decades on the workings of an economy that’s grappling with the after-effects of a pandemic — including how higher rates may affect inflation that’s potentially been caused by widespread supply constraints and other capacity shortages.
“We are seeing progress on the supply side. A lot of the supply chain issues we had a year or two ago, with the exception of chips and switchgears, seem to be in much better shape,” Barkin said. “You’ve seen labor force returning to the market at much higher levels, so you're getting some help on the supply side. And we’re doing what we do on the demand side, right? And we’re just trying to calibrate that.”
Barkin, who worked for decades at the consulting firm McKinsey before joining the central bank, now spends much of his time visiting and speaking with business leaders to understand the impact of monetary policy.
He’s argued that the US economy may have proven more resilient to higher rates in part because businesses are still reacting to the long tail of the pandemic. That means they’re more worried about building out extra capacity than being caught over-supplied.
“If you just spent a year trying desperately to fill empty jobs, you’re going to be a little cautious before laying people off cavalierly,” Barkin said.
“If you look at the layoff announcements by businesses over the first half of the year, for example, you'll see they’re massively disproportionately professionals — not frontline workers, not skilled trades and manufacturing or construction workers,” he said. “And I think that’s because people genuinely are concerned they won’t be able to find those people if they lay them off.”