A Real (Estate) Challenge For Market Monetarists and Orthodox Macroeconomists

As David Glasner recently noted, no plank of orthodox macroeconomics is more sacred today than that international free trade is good, and that even large and chronic trade deficits don´t matter.

But an overlooked 2012 paper from the New York Federal Reserve, entitled House Price Booms, Current Account Deficits, and Low Interest Rates, raises serious concerns about chronic trade deficits, particular given the deeply entrenched ubiquity of property zoning.

The paper posits, “One of the most striking features of the period before the Great Recession is the strong positive correlation between house price appreciation and current account deficits, not only in the United States but also in other countries that have subsequently experienced the highest degree of financial turmoil.”

The short story is this: When a nation consumes more than it produces, and imports the difference, it must sell assets to finance the shortfall. Foreigners are especially keen on the perceived security of real estate, and, of course, can leverage up with the ready assistance of domestic banks.  The term “commercial bank” has become a misnomer, as more than 75% of U.S. bank lending in is on property. Thus, huge trade deficits equal huge capital inflows into domestic real estate.

Property Zoning

The universal culprit in this trade-deficits-results-in-house-price-booms scenario is property zoning, a feature of modern economies deeply embraced by both the propertied and financial classes, but (consequently?) rarely a topic in macroeconomic discussions.

To mix metaphors, property zoning is the Achilles Heel of macroeconomic blind spots.

Without property zoning, nations such as Australia, Canada and the United States could produce more housing to soak up the foreign capital inflows, even after those flows are leveraged five-to-one by domestic banks. The U.S. runs about $500 billion a year in trade deficits.

But with ubiquitous zoning, house prices soar to equate supply and  demand, generating inflation and reducing living standards of the domestic population.

Obviously (and disastrously in 2008), the housing-cost inflation sends signals to acutely attuned central bankers.

The Challenge

As Market Monetarists, we have posited that central banks should target nominal GDP growth, level targeting, or NGDPLT.  This still strike me as the best course for a central bank. However, there is the menace of trade deficits on the playing field, in dread combination with property zoning. Housing costs are a large part of inflation metrics, and of real living standards.

A constantly growing economy running large trade deficits, and in the modern-era marked by nominally low interest rates and property zoning, will have rising house prices and consequences for real living standards. We see middle-class populations in Australia, Canada and the U.S. have become dubious about the benefits of globalism. Moreover, how long until the Fed suffocates growth to flatten housing costs?

This house-price-and-trade-deficits scenario is one that Market Monetarists and orthodox macroeconomists need to address.

PS–How far is the topic of “property zoning” out of the orbit of macroeconomic policy and monetary policy discussions? Pluto comes to mind.

Andrea Ferraro, the author of the NY Fed paper referenced above—a paper about house prices!—does not even mention the topic of property zoning. She instead posits that banks lowered credit standards to soak up the flow of foreign capital, and funnel it into housing, causing the price boom. So, trade deficits boomed housing prices, with a shot of too-easy money.

Well, yes…and no. Is not supply and demand a fundamental of economics anymore? Without property zoning, would not have housing supply boomed, and not prices?


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