You May Already Own One Big Inflation Hedge

Inflation is on everyone’s mind, with prices rising at the fastest rate since the early 1980s. And, unlike earlier in the year, wages aren’t keeping up. The net effect is that many consumers’ purchasing power is now declining.

These rising prices may persist for much of this year. While the U.S. Federal Reserve is rushing to increase borrowing costs in an effort to slow consumer demand, the effect won’t be immediate. Plus, some of the inflationary pressure is due to issues like high fuel costs and remaining supply-chain issues. U.S. policymakers will have trouble addressing these global problems. Indeed, these issues can help explain why inflation in Europe is now just as high as it in the U.S.

That’s the bad news. But I want to write this article as a reverse “praise sandwich.” You know how when you give people feedback, you are supposed to go good-bad-good? For example, my boss once said to me: 1) I like your shirt (good news); 2) your research paper sucks (bad news); 3) you can go now (good news). So, this post is going bad news first — inflation is bad and may be persistent. But there’s good news next. Yay! But, then bad news last. Boo.

The Good News: Home Ownership is an Inflation Hedge

When inflation is high, the prices of life’s necessities can increase dramatically. For example, food prices — which are notoriously volatile — have risen by over 10 percent since May 2021, even faster than overall inflation. If housing prices were to increase significantly too, then the cost of two main necessities of life, food and shelter, would be spiraling upwards. But, for many people, that hasn’t happened.

Why not? Because for the nearly two-thirds of Americans who own their home, monthly payments are typically fixed. After all, for people with a 30-year fixed rate mortgage, the amount paid from month-to-month and year-to-year is a constant. Contrast that to rent, where the cost tends to increase with inflation. For example, over the last year rents have increased by about 5.5 percent.

The end result is that the longer people live in their owned homes, the more affordable their house becomes. For people who rent, that trend doesn’t happen — their rent tends to increase more than their wages. So, over time, renters spend more and more of their income on housing. A simple way to see this fact is to look at how housing costs as a share of income evolve as someone lives in the same residence. The figure below shows these data. The figure illustrates that homeowners see the share of their income devoted to housing drop over their tenure at a home. For renters, the opposite happens.

Figure 1. Housing Share of Income by Tenure at Home

Source: American Housing Survey, 2019 accessed in STATA form from the Blog of Tim Murray.

The Bad News: Home Ownership is Very Unequal

If you look again, the figure above also highlights an inequality in how much income is devoted to housing between these two groups. Renters pay a lot higher share, and the reason is that they have generally lower incomes. So, the people whose shelter is most vulnerable to inflation likely have a lower ability to bear the cost.

The problem is that home ownership requires the accumulation of significant assets to win the approval of a bank for a mortgage and support a down payment. Therefore, it shouldn’t be surprising that home owners have much higher incomes than renters. According to the American Housing Survey, the median owner makes about $6,600 a month. The median renter about half as much, at $3,200 a month. The net result is that inequality in home ownership tends to mimic racial/ethnic inequality in income, with Black and Hispanic households owning much less often than others.

Figure 2. Home Ownership Rates by Race, Ethnicity, and Income

Source: American Housing Survey, 2019 accessed in STATA form from the Blog of Tim Murray.

So, as inflation in rent eats away at incomes, it tends to be people who often already have lower income to start. Indeed, a common theme of this blog has been the idea that when bad things happen to our economy, they tend to affect people who are less equipped to deal with it.

Improving Housing Equity

To improve equity in home ownership, the first obvious barrier to overcome is discrimination. Within the last decade, economic studies using actors have found that Black and Hispanic buyers are shown fewer units by real estate agents and steered towards lower-income neighborhoods. It goes without saying that for housing equity to be achieved, these practices need to stop.

But, discrimination is not the only issue. And, in any case, ending discrimination would do nothing for lower-income white families, about half of whom also do not own a home. Economically, the biggest barrier to home ownership is the down payment. According to Alex F. Schwartz in his book “Housing Policy in the United States,” over 90 percent of renting families would not be able to afford to purchase even a modestly priced home.

In that same book, Schwartz provides several potential solutions to overcome this barrier of affordability. The most obvious is government-provided down payment assistance. These programs are designed to level the playing field between lower-income and higher-income buyers, the latter of whom are likely to have down payment assistance from family. Some have worried that those receiving this type of assistance are more likely to default on their loans (after all, they needed help to purchase the home). But, the evidence suggests that this negative effect does not play out.

Of course, given that the U.S. is currently in an inflationary period, government spending on a down payment program may not be prudent. An alternative approach would be for government policy to attack the supply-side of the problem. Currently, many localities have what are called “exclusionary-zoning” policies. Common examples of these policies include restricting building to single family detached homes on lots of at least a certain acreage.

These policies ensure that multi-family homes — which are typically more affordable — are excluded from these areas. The Biden Administration has expressed interest in a grant program to encourage localities to end these sorts of exclusionary policies. Doing so would be a good idea. After all, it wouldn’t just make it easier for disadvantaged groups to buy a home, it would also allow more homes to be built. And more homes mean lower prices. In other words, ending exclusionary zoning wouldn’t just be good for equality, it would actually fight the very inflation eating away at renters income. It’s an obvious win win, and one we should all be rooting to happen.

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