New Fed Policy Likely to Further Bolster California Housing Prices

August 27, 2020 Updated: September 2, 2020

Commentary

The Federal Reserve officially changed its target for inflation on Aug. 27. Going forward, the U.S. central bank will “anchor” its inflation target at 2 percent, compared with its previous target within a range of zero to 2 percent.

The policy adjustment came via an update to the Fed’s “Statement on Longer-Run Goals and Monetary Policy Strategy,” first published in 2012 and most recently revised in 2019. Fed Chairman Jerome Powell used a speech at an annual Fed-sponsored symposium to explain the change.

During his speech, Powell emphasized what it means to “anchor” rates at 2 percent: If inflation falls below 2 percent for a number of years, then the Fed subsequently will have the flexibility to set an inflation goal of “just over 2 percent” so that, over time, the long-term inflation target stays at 2 percent.

Powell emphasized that in the same way high inflation expectations had set in and eventually hurt the economy of the 1970s and ‘80s, he’s concerned that if decision-makers start to expect inflation always to be below 2 percent, there’s a danger of people coming to expect increasingly lower inflation, which could also be bad for the economy.

He didn’t explain to his audience of more than 20,000 people that negative inflation, or deflation, can be bad because lenders might balk if they think collateral values might go down.

SoCal Home Prices

Southern California is already one of the hottest markets for single-family homes, because of the severe housing shortage that existed before the pandemic on March 12.

Now, with shelter-in-place orders as well as governmental and judicial responses meant to keep tenants and mortgage payers in their current homes, fewer people in Southern California are relocating. Young families are bidding up home prices faster in Southern California than potential home buyers are in the rest of the country, on average.

We wrote about the quickly increasing value of Southern California homes for this column on Aug. 25.

The Fed’s favorite indicator of inflation is the so-called core PCE deflator—a measure for urban-area changes in price that excludes food and energy costs (which are subject to variation, due to weather and other short-term phenomena).

So domestic inflation disproportionately affects goods and services that aren’t easily traded with other countries. If toys from China become too expensive, the toy manufacturer can move its factory to a lower-cost site. However, the cost of haircuts and the value of homes are both functions that are entirely related to domestic supply and demand and domestic inflation.

If housing prices go too high, people move, infrastructure might get built, density might become denser, and policies might shift (such as allowing additional domestic units, or ADUs, in pre-existing neighborhoods).

The core PCE deflator has held at just 1.0 percent for the 12 months ending in June, only 1.6 percent throughout 2019, and hit the new target—2.0 percent—for all of 2018.

Prior to that, the core PCE was 1.7 percent in 2017 and 1.8 percent in 2016.

So, if the Fed achieves getting inflation to, say, 2.5 percent per year over the next few years, this will likely have a disproportionate effect on boosting home prices in Southern California (for the reasons stated above and in our Aug. 25 article).

While that’s not to say that Southern California home prices are certain to go up over the next few years, it does indicate that Southern California home prices are likely to be higher five years from now than they would have been had the Fed not started “anchoring” on a higher inflation target.

Whether California home prices are actually higher in five years will primarily be driven by supply and demand. Supply might be affected by new transportation links or a big increase in ADUs—such as a backyard or upstairs “granny unit,” “casita,” or “in-law unit”—and demand will be affected by income levels, family formation, and the state’s net immigration/emigration numbers.

Additionally, income levels will be a function of the jobs market, which is getting a big boost currently not only from the big “Netflix effect” in Hollywood, but also from all those Bay Area tech companies.

In any case, home prices in Southern California will most likely be getting a boost from the Fed’s major policy change.

Tim Shaler is a professional investor and economist based in Southern California. He is a regular columnist for The Epoch Times, where he exclusively provides some of his original economic analysis.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.