At the heart of the cost-of-living crisis affecting American households is the issue of housing affordability. Housing services account for approximately a third of American consumers’ spending, by far the most important item in their budgets. Even prior to the pandemic, the median rent rose faster in nearly every state than the median income of renters between 2001-2018, putting affordable housing increasingly out of reach.
The pandemic only exacerbated this housing affordability crisis. Between December 2021 and December 2022 rents as measured by the Consumer Price Index rose by 7.5%, dwarfing the growth in rent experienced in recent decades. And while other sources of inflation have moderated, rental inflation now makes up the lion’s share of persistent inflation pressure.
Solving the housing affordability crisis requires public investment and regulation, which is the handiwork of state and federal policymakers. Congress, by adhering to austerity and failing to address the cost-of-living crisis, has inadvertently shifted the onus of managing high prices onto a solitary institution, the Federal Reserve, instead of fulfilling its own duty to invest in a robust economy. Relying on outdated theories of how the economy works, the Fed has not only failed to rein in housing prices, but has put housing affordability further out of reach for millions of people.
Relying on outdated theories of how the economy works, the Fed has not only failed to rein in housing prices, but has put housing affordability further out of reach for millions of people. ”
In a speech at the annual Jackson Hole Economic Policy Symposium, Fed Chair Jerome Powell outlined a theory of how Federal Reserve interest rate hikes affected the housing market: “In the highly interest-sensitive housing sector, the effects of monetary policy became apparent soon after liftoff. Mortgage rates doubled over the course of 2022, causing housing starts and sales to fall and house price growth to plummet. Growth in market rents soon peaked and then steadily declined.”
But this theory fails to acknowledge three key ways rate hikes exacerbate housing unaffordability.
Current and prospective homeowners who face higher mortgage rates are direct casualties of the Fed’s interest rate hikes. Mortgage rates shot up after the Fed’s announcement in December 2021 that it would hike interest rates in 2022. Since then, average rates for 30-year fixed-rate mortgages have more than doubled, rising above 7%. This has resulted in “lock-in” for homeowners who would like to take advantage of falling house prices by moving to a new home but cannot afford the cost of high mortgage rates. For prospective homeowners, higher mortgage rates mean delaying the purchase of a home or swallowing a more expensive mortgage. This matters not just for cost-of-living today but also because it prevents families from building wealth.
In the short-run, there are also negative spillover effects of higher mortgage rates on renters. Because higher mortgage rates drive up the cost of purchasing a home, many people choose to stay in the rental market longer, increasing demand for rented units and ultimately driving higher rents for everyone. These rent dynamics have important distributional implications in a world where landlords have virtually all the power in the rental market. Across-the-board rent increases mean fewer affordable options for renters while landlords are able to pocket an even higher share of renters’ income. By raising rates in an environment of constrained supply and unbalanced power, the Federal Reserve empowers landlords to profit at the expense of struggling families.
Construction of new housing units is a key determinant of rental prices because housing markets are besieged by a chronic scarcity of supply. There simply are not enough affordable homes for low-income renters. Higher interest rates drive up the cost of financing housing construction, exacerbating supply-side shortages. The construction industry is highly sensitive to monetary policy, both because higher interest rates directly raise the cost of borrowing to fund new projects and because it becomes more difficult to hire and retain construction workers. And the worst may be yet to come as older projects, initiated before interest rate hikes, phase out while new projects become more expensive to start.
Federal Reserve rate hikes are the wrong tool for making housing more affordable. ”
Federal Reserve rate hikes are the wrong tool for making housing more affordable. Policymakers need to instead prioritize public investments and protecting the rights of tenants. Congress should play an active role in building social housing that grows supply while ensuring access for low-income residents. These investments should be coupled with rent regulations that protect tenants from price-gouging and exploitative landlords. We must tackle these issues head on rather than relying on indirect tools that are poorly targeted.