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WHY IS HOUSINGNIMBYOEROERBISBISBISYour browser does not support the element. so expensive? Explanations have tended to fall into two camps. One emphasises a gummed-up supply side: a range of restrictions on land use and campaigners have stymied housebuilding across the rich world. The other camp focuses on demand: a long-term fall in real interest rates has bid up the prices of all assets. Cheaper credit means more expensive housing. Yet even as interest rates rose across the rich world in the early 2020s, prices barely budged. Why? A range of recent papers suggests that the interaction between fixed supply and changes in demand explains the puzzle.For most people, a house is a home. To economists it is an income-generating investment. Both are right. On the one hand, for landlords that income is rent. On the other, owner-occupiers receive their income in kind: the consumption of the “housing services” a home provides. Either way the price is largely the same; in essence, both receive rent. For the purpose of inflation statistics this is known as “owner equivalent rent” (), and is the main way in which housing shows up in consumer-price indices. accounts for about a quarter of the American inflation measure.All else being equal, lower interest rates ought to lead to higher house prices. The ratio of rent to a house’s price is similar to the yield on a bond. Both can, in turn, be compared to the interest rate the central bank sets on money. Across financial markets the rates of return on different assets, adjusting for different levels of risk, should converge—otherwise a landlord could sell their portfolio of houses and lock in a higher return in the stockmarket or vice versa. A cut in the central-bank rate raises the market price of bonds, shares and houses in the same way to keep the rates of return in sync. Some economists used this principle to identify a housing bubble before the crash of 2007 as the ratio of house prices to rents rose above what could be justified by interest costs.In its latest quarterly review, the Bank for International Settlements () examines what a gummed-up housing market means for monetary policy. Ideally, developers should respond to the higher prices brought on by lower interest rates by building more houses and hiring more workers, generating inflationary pressure; higher rates should have the opposite effect. That response has been diminishing over time. During the 1970s, the authors calculate, a 1% increase in home prices produced a 6% increase in new construction; by the 2000s this had dropped to 4%. The authors put this down to a combination of stricter land-use regulation and falling productivity in construction. Rather than stimulating investment, monetary policy works through other channels: fewer new homes are built, and existing ones become more expensive.Whereas many asset prices adjust almost immediately to changes in monetary policy, the housing market takes longer. It can take months or even years to buy or sell a property. The researchers find that in areas where the supply of homes responds to higher prices there is a one-off shift in house prices: over about a year they rise by about 1.5% following a one-percentage-point cut in interest rates; the rents-to-prices ratio falls and then stabilises. When construction is slow to respond, however, house prices just keep on rising. The authors think this might be because would-be homeowners extrapolate that house prices will continue to rise in the future, which could compensate for a lower yield. Rather than boosting construction, homeowners get a windfall and spend more, generating inflationary pressure through a different channel. They could, for instance, splurge on restaurants and holidays, pushing up wages in those industries.That does not mean frustrated young renters should hope for an increase in interest rates to bring prices down and homeownership within reach. Monetary policy changes the appeal of owning a home. A paper by Daniel Greenwald of New York University and Adam Guren of Boston University looks at how the rental and house-buying markets interact with each other. In theory, as house prices rise, landlords should be willing to sell to wannabe homeowners. Bringing more sellers into the market relieves some of the upward pressure on house prices after a fall in the cost of credit. It also means the rate of homeownership can increase even if not many new homes are built. Yet in reality this effect is not borne out. The rental market and the homeownership market are almost entirely segmented. When rates rise, and mortgages become more expensive, renting becomes more attractive. That increases demand for the relatively fixed number of rental properties. At the same time, landlords are offered higher risk-adjusted yields on other assets and need to be compensated for missing out on them. A paper focusing on Ireland by Juan Castellanos of the European University Institute and Andrew Hannon and Gonzalo Paz-Pardo of the European Central Bank finds that higher rates actually tend to push rents up. In the same vein, a paper by Daniel Dias of the Federal Reserve and João Duarte of the Nova Business School, focusing on America, finds that tight money can increase “shelter” inflation.That helps explain some of the recent puzzles of the housing market. Higher rents mean that house prices do not have to fall so far to maintain the yield differential between housing and other assets after monetary policy is tightened. Shelter inflation, meanwhile, has been one of the most stubborn components in the last mile of disinflation for the Federal Reserve. Deniz Igan of the calculates that for potential buyers, who care about home prices, their income and mortgage costs, housing is more unaffordable than at any time since the meltdown of 2007. As long as housebuilding remains weak, neither cheap nor expensive money will bring relief.
