The Grumpy Economist: Residence inflation


This stunning graph comes from (Courtesy Andy Atkeson who used it in a pleasant dialogue of an amazing paper by Ivan Werning on the Minneapolis Fed Foundations of Financial Coverage convention.) 

The central traces that do not transfer a lot are the common lease. That is the amount utilized by the Bureau of Labor Statistics to compute the patron value index. The blue and yellow traces are the lease of recent leases. 

The very first thing this informs is the financial idea of “sticky costs.” Residence rents are a basic “sticky value;” the lease is mounted in greenback phrases for a yr. So, landlords deciding how a lot lease to cost, and folks deciding how a lot they’re prepared to pay,  stability rents now vs. larger rents sooner or later. If everybody believes that inflation will likely be 10% over the subsequent yr, then it is smart to lift the lease 5% now, and to pay the 5% larger lease, as a result of  the financial savings on the finish of the yr stability the fee to start with. (Clearly, the economics are rather more delicate than this, however you get the thought.) And Voila’, you see it. 

The graph additionally says there’s some predictability and nomentum to inflation. Inflation shouldn’t be a shock to forecasters. In case you see rents on new leases a lot above common rents, it is a fairly good guess that common rents will likely be rising sooner or later! This sort of phenomenon could also be beneath exploited in formal inflation forecasting. 

And, on the persevering with hypothesis whether or not inflation will go away with rates of interest nonetheless considerably under present inflation, the graph does appear a number one indicator that the rational expectations mannequin is profitable.  

Clarification: After all, the graph says nothing about causality; did new leases rise sharply as a result of individuals anticipated inflation in common leases, or did new leases rise for different causes, and we’re simply seeing the previous theorem that marginal  > common when common is rising. However it’s in keeping with the expectations story, and illuminates that story properly.