MONETARY GROWTH AND HOME HOME PRICE INFLATION

Our last post discussed how growth in the monetary aggregates doesn’t always end up causing a rise in the basket of goods and services measured by the Consumer Price Index. Increasingly we have seen the inflationary effects in financial assets. We demonstrated this through graphs connecting money supply to the stock market and securitization activity. We were missing an obvious one, money supply versus housing. Coincidentally (or not….maybe they simply enjoy Annaly Salvos and thought to add to the discourse), just today the St. Louis Fed published a short essay that addresses that very topic. In “Money Supply, Credit Expansion, and Housing Price Inflation,” economist Yi Wen put together the chart below, which shows the relationship between 10-year moving averages for M2 growth, housing price inflation for existing and new home sales, and CPI inflation. “In particular,” says Wen, “the steady increase in the housing price inflation rate since the early 2000s is closely associated with the steady increase in the money supply during the same period.” Proving that trees don’t grow to the sky, home prices have collapsed while M2 growth has stayed relatively constant.  Wen cautions that while the chart does not show any causality, the credit creation that drives home prices and M2 may have a common driver-low interest rates.  ”[P]olicymakers may want to closely watch housing price inflation, not only because it leads CPI inflation, but also because an overheated housing market may encourage more risk-taking behaviors by banks and cause the aggregate money supply to increase, resulting in excess aggregate demand and higher inflation risk.” Economists have such a flair for understatement.