Do higher interest rates in 2024 make inflation ...HIGHER? Makes sense to me

All the way back to high school, we're taught that the Federal Reserve raises interest rates to slow inflation, with a slower economy as a side effect becasue of higher borrowing costs. But what if that doesn't work in 2024, and in fact, the higher interest rates are causing housing prices to be higher than they'd otherwise be?

That's a theory that I saw floated out a few weeks ago, and it's starting to add up to me.

The Federal Reserve raised rates the most in decades to bring down inflation. High borrowing costs are supposed to put the brakes on the economy to keep consumer prices from rising too quickly. But Jack Manley at JPMorgan Chase argues that the Fed’s current rate range of 5.25% to 5.5% are actually inflationary at this point, and that prices won't stabilize more until the the central bank starts cutting.

“A lot of what’s going on with inflation today can be linked very closely with the level of interest rates,” Manley said. “You slice and dice inflation and whether you’re looking at the headline number, whether you’re looking at the core number, you’re removing the goods equation — so much of it has to do with the rate environment.”...

Oppenheimer’s John Stoltzfus hinted last week at the idea that lower mortgage rates would prompt more people to sell their homes, leading to more supply and potentially softer prices. If people could afford to buy homes, they wouldn’t need to rent as much, and rents could stabilize. Manley pointed to housing and also to inflation from auto and other insurance premiums, which he also noted was somewhat tied to rates.

“You’re not going to see meaningful downward pressure on shelter costs until the Fed lowers interest rates, mortgages come down to a more reasonable level, and supply comes back on line, because people are willing to step into that market,” Manley said.

Here's the interview clips on Bloomberg where Manley goes into his theory some more, and how March's gasoline-driven increase in inflation is something the Fed should largely ignore when making future decisions on what to do with interest rates.

"A lot of what's going with inflation today can be linked very closely to interest rates." Jack Manley of JPMorgan says we've entered a 'chicken and the egg' phase between the Fed and inflationhttps://t.co/CmyQbFmu03 pic.twitter.com/KTrabyEiIV

— BSurveillance (@bsurveillance) April 8, 2024

I look at our current situation with our home as an example of this. We're not looking to move, but if we did, it would take a whole lot more to justify it than normal. We're locked into a 3% refinanced mortgage from 2020, based on what we paid for our house 11 years ago. Our recent home assessment has our house's value at twice the amount we paid for it, which is nice for net worth, but really doesn't do much for us now beyond giving us more ability to take out a line of credit for a Home Equity Loan (albeit at a higher rate than 3%).

And if we wanted to move, we'd have to either pay in all-cash at these elevated prices (not possible for us) or take out mortgage loans at 7% vs the 3% we are paying now, so us and a lot of others are staying in our homes. Manley notes that this decreases supply of homes on the market, and drives up prices for homes even further. It also means more people aren't willing or able to buy houses, so they have to rent, which means demand and prices for rental housing go higher.

Reuters also had a rundown of this theory which cited a study by the Fed itself which indicated that higher interest rates can indeed inflate housing prices.

....a discussion paper by economists Daniel Dias and Joao Duarte, [was published] by the Fed's Board of Governors in 2019, less than a year before the onset of the COVID-19 pandemic.

The study concluded that "housing rents increase in response to contractionary monetary policy shocks" and that "after a contractionary monetary policy shock, rental vacancies and the homeownership rate decline."

Put another way, the research showed that rental costs tend to surge as rising mortgage costs force those put off from buying houses to rent instead - while also reducing the number of potential homes to rent.

And reinforcing the peculiarity of the response of rent, the paper showed all other main components of the consumer price index (CPI) either decline in response to tighter monetary policy or are not responsive.

Reuters includes this chart which shows that the higher interest rates have effectively brought down inflation for goods in this country over the last 18 months, but housing and services are up by more.

And a huge driver of that increase in services? The higher cost of car insurance and repairs and maintenance of both autos and homes, which is a downstream effect of cars and homes having higher values. If lowering rates freed up the chances of more purchases of newer assets and and moves, maybe those industries couldn't charge as much either. Just a thought.

Much like how "the experts" kept anticipating a recession that never came in 2022 and 2023 in the wake of these higher interest rates, maybe we need to recalibrate what is causing inflation in 2024, and that higher interest rates might not be the way to limit price increases. In the current rate situation, I think many Americans feel trapped, and that they're being pulled on a ride that limits the comfort they should have from steady employment and growing wages.

A more affordable supply of both housing and vehicles would help to alleviate one of the few real problems in this economy - where things that were regular bills in the standard of living now feel like annoying burdens to many. Cutting interest rates from their 23-year highs might well be a way to lessen those burden, and expand the possibilties. It's all the more reason that the Fed should be dropping interest rates sooner than later, because that move would seem likely to increase the options for both homeowners and renters, encourage more supply of homes and vehicles to go onto the market.