How Monetary Policy Determines Housing Prices

That there are asset-bubbles in the U.S., blown by the Federal Reserve, is an ongoing boogeyman erected and genuflected to by the tight-money crowd.

As we can see from the chart below, San Francisco and Houston operate under different monetary authorities. Prices have exploded in San Francisco over the years, and done very little in Houston.

Okay, getting serious for a moment, we can see that monetary policy can easily be trumped by restrictions in supply (George Selgin has noted this, in relation to agricultural products). Tightening up monetary policy will not bring about a greater supply of housing, just as monetary tightening will not increase supply of corn in a drought. In fact, tighter money might restrict new housing, or dissuade farmers from planting corn.

Housing is a large component of living costs, about 30% nationally though more than 50% along the coasts, in many cities. Rising housing costs impact inflation.

Conclusion

While issues such as taxes and trade get the headlines, a major and growing issue in the U.S. is ubiquitous restrictive property zoning, and the false signals zoning sends to the Fed. Indeed, the “housing bubble” that led to Fed over-tightening in 2007 barely surfaced in Houston, but was highly prominent in San Francisco.  Obviously, the “housing bubble” was not Fed-induced.

Moreover, if housing was in a “bubble” in San Francisco in 2008, it is even more so now.

In truth, regional housing prices are highly conditional upon regional employment growth, property restrictions and inflows of foreign capital. Nations which run large chronic trade deficits tend to have rising house prices, as seen in Hong Kong, Australia, New Zealand, Canada, Great Britain and parts of the U.S.

Orthodox macroeconomics and conventional monetary policies are ill equipped to deal with this emerging econoscape, which does not fit neatly in prevailing theories and ideologies.  Free trade deficits can explode housing prices, while tighter money can actually exacerbate housing shortages.

For investors, this presents a tricky playing field. The Fed still thinks monomaniacally about inflation, threatening recession. The prospects for well-placed residential REITs or investment vehicles acquiring class B housing in restricted markets are interesting.

Unfortunately, the U.S. appears committed to both trade deficits and property zoning for the foreseeable future.

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