Americans are feeling the sting of higher inflation for the first time in two generations, and they are rightly unhappy. Some blame the runaway inflation on government policies that have shored up the finances of pandemic-stricken households and call for the government to stand down. That would be a grave mistake, however, as it will take the help of policymakers to address one of the most critical drivers of inflation: the housing shortage.
Inflation has become a brutal head wind for the recovery, with rising prices tempering the benefit of strong gains in jobs, wages and investments. Families have more to spend, but their dollar isn’t going nearly as far, a frustrating dynamic that is undermining consumer confidence and slowing economic growth.
The pandemic bears much of the blame, scrambling the supply of a remarkably broad range of goods and services. The poster child for this systemic dysfunction is the vehicle industry. The wave of coronavirus infections caused by the delta variant in the late summer and fall forced semiconductor plants in Asia to shut down. Without the chips produced in these plants, auto manufacturers had to scale back. And without enough cars to meet demand, prices skyrocketed. Roughly the same thing has occurred throughout the economy, driving up the price of everything from food to furniture, and clothes to electronics.
The omicron wave hasn’t helped, but as it peaks we are seeing signs that the pandemic may finally loosen its grip on our lives and the economy. As it does, global supply chains will begin to normalize, and the pervasive shortages we have seen will no longer put so much upward pressure on pricing.
There is one glaring exception to this hopeful story, and it is a big one: housing. Home builders have been unable to keep up with demand for well over a decade, held back by restrictive zoning requirements, high permitting costs and often an inability to get affordable financing to buy land and build homes. The pandemic has made matters worse, with acute shortages of materials and labor, but the problems from before the pandemic show no signs of fading with the effects of the virus.
The scale of this shortfall is unnerving. We estimate that home builders have built on average 150,000 fewer homes a year than we have needed, going all the way back to the financial crisis. The 1.7 million-home shortfall amounts to an entire year of home building.
The shortfall has sent the cost of housing through the roof. Home prices have more than doubled over the past decade, rising close to 20 percent in the last year alone. And rents are up a record 13.5 percent nationwide over the past year, with increases of more than 20 percent in metropolitan areas such as Austin, Las Vegas, Phoenix and Tampa. All of this is draining the savings of renters, putting homeownership further and further out of reach.
It is also putting enormous upward pressure on inflation. Housing alone counts for almost one-third of the typical household’s budget, making it the single biggest component of the consumer price index, or CPI, the most popular measure of inflation. Food and energy together account for about one-fifth of the CPI, and all other goods, from clothing to vehicles, another one-fifth. No matter what happens to pricing across most goods, inflation will remain high as long as the cost of housing continues to rise so quickly.
If policymakers are serious about reining in inflation, then they have little choice but to take on the shortfall in housing supply. This means improving the economics of building enough to overcome the costs that have been holding builders back in recent years. This can be done in any number of ways, including tax breaks, grants, access to less expensive capital and incentives to get local decision-makers to ease zoning rules and restrictions on development.
President Biden has provided a good place to start in his Build Back Better legislation, which includes $18 billion in tax incentives for new construction and renovation, $30 billion in grants for new construction and renovation, and $5 billion in grants for communities committed to removing the impediments to building more affordable housing, all over a 10-year window. Such a package would lead to the building of tens of thousands of more homes a year, meaningfully closing the gap between supply and demand that is driving the surge in home prices and rents.
There should be strong bipartisan support for a package along these lines. After all, the affordable housing shortage is a problem in every state and almost every congressional district. Whether Congress uses this bill as its starting point or not, though, policymakers need to step up, and those worried about inflation should be first in line. While the other drivers of inflation are set to ease in the coming months, the shortfall in housing isn’t going anywhere unless policymakers do something.
Jim Parrott is co-owner of Parrott Ryan Advisors and nonresident fellow at the Urban Institute. Mark Zandi is chief economist at Moodys.com.