Real Estate Bubble Burst: The Fed’s Tool to Lower Inflation is Backfiring, Says Former White House Adviser

Real estate bubble burst looming as Fed's rate hikes inflate housing costs, warns ex-White House adviser.

The real estate bubble burst is becoming an imminent reality as the tool the Federal Reserve is using to lower inflation is having the exact opposite effect. According to housing expert Jim Parrott and Mark Zandi, chief economist at Moody’s Analytics, the Fed’s rate hikes are inadvertently sustaining inflation due to the flawed methodology in calculating homeownership costs.

The Misjudgment in Inflation Measurement

In a recent Washington Post op-ed, Parrott, co-owner of Parrott Ryan Advisors and former White House economic advisor, alongside Zandi, criticized the Federal Reserve’s approach to measuring inflation. The core of the issue lies in how the personal consumption expenditures deflator and the consumer price index estimate the cost of homeownership. These metrics rely on notional rent calculations, which don’t reflect the real costs most homeowners face, given that many have fixed-rate mortgages or no mortgage at all.

Flawed Metrics and Their Impact

The reliance on notional rent metrics is problematic because it doesn’t accurately capture the true cost burden on homeowners. Parrott and Zandi argue that if the Fed abandoned this flawed methodology, inflation would be closer to the 2% target. However, as it stands, the Fed’s approach is inflating the perceived costs of homeownership, thereby keeping inflation figures higher than they might otherwise be.

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The Housing Supply Dilemma

The Fed’s aggressive rate hikes have also exacerbated the housing market crisis by tightening the supply of new homes. High-interest rates discourage both new construction and homeowners from selling their properties, which they bought at lower rates. This shortage is driving up both buying and renting costs, counteracting the Fed’s efforts to lower inflation.

Real Estate Bubble Burst on the Horizon

The real estate bubble burst scenario is becoming more likely as the Fed’s measures to combat inflation are ironically inflating housing costs further. Parrott and Zandi’s insights highlight a critical flaw in current economic policy, suggesting that a revision in the Fed’s methodology could align inflation more closely with its targets. Until then, the housing market crisis is set to continue, with significant implications for both buyers and renters across the country.