Idle Thoughts on Monetary Policy and Closed Access Housing

I’m not really even sure what to do with this, but it seems important.

In one way, we are back in a similar context to what we were in before 2008. In one of my Mercatus papers, I noted that population growth in the Closed Access cities has become counter-cyclical. They don’t build enough housing to handle pro-cyclical changes in per capita demand, so when the economy is strong, they have room for less people.

They are losing population today, even more than they had before 2008.

One thing I like to do is check U-Haul rates from Los Angeles to Phoenix. It tends to run 2-3 times more from LA than it does in the other direction. I think this should be a decent recession indicator. As long as the economy is growing faster than the housing stock in LA can grow, there will be some unfortunates who will be displaced from LA. Unfortunately, in a zero sum economy, one way to confirm that things are going well is to find its losers. If U-Hauls stop flowing out of LA, it’s probably time to get defensive.

Before 2008

Figure 1 compares employment growth in the Closed Access cities to national employment growth. In the late 1990s they were similar. But, seams were bursting in the Closed Access cities. As we recovered out of the 2001 recession, there was no more room to bend, and they started to break. Migration increasingly flowed out into the rest of the country. The Closed Access cities grew more slowly than the rest of the country.

Figure 1

I think this led to some interesting dilemmas for the Fed. There were two economies. There was a Closed Access economy that was somewhat zero sum. Real growth was capped and additional growth created inflationary rent.

In the rest of the country, real growth was stimulated by the extra migration out of the closed access cities.

So, when growth was hot, part of the country had high real growth and part of the country had inflation. They were two different economies.

In Figure 2, I compare real GDP growth in Florida, Arizona, the US, and Massachusetts. (The other Closed Access areas don’t align well with state boundaries.)

From 2002 to 2006, Florida and Arizona were growing faster than the US and Massachusetts was growing slower. Then they flipped as recession hit.

Figure 2

When the Fed looked at the aggregate US economy, they just saw an economy that was running a bit hot. But, the inflationary places weren’t the growing places. So, how do you apply monetary policy to that?

In 2005, real growth in Florida and Arizona was 6% and 7%! Effectively, the Fed had to slow down real growth! And, what was driving that growth? Families regionally migrating to reduce rent inflation.

So, in 2006 and 2007, the Fed collapsed real growth in Florida and Arizona. Now, regional real growth converged between the Closed Access cities and the Contagion cities and inflation increased because of the decline in homebuilding and the decline in economizing regional migration.

After 2008

For the decade after the ensuing crisis, the Fed and federal mortgage regulators inadvertently coordinated to keep national real growth low enough to stay under the growth capacity of the Closed Access cities. That was just starting to change before the Covid shock arrived. Los Angeles has had negative population growth since 2017.

Then we managed the Covid shock without excessively harming national incomes or housing production (though it is still at a relatively low level), and now the Closed Access cities are into pretty steep population decline. High growth means that the closed access cities have to shrink. Growth oriented monetary and fiscal policy coming out of the covid shock meant that closed access cities had to shrink.

We don’t yet have enough housing construction for that to pump up real incomes in the rest of the country that much. Partly, population growth is lower. Partly, the rest of the country now just has high rent inflation like the Closed Access cities do.

Recent trends in international immigration appear to have pushed up national population growth, at least temporarily. And, home prices appear to have finally recovered enough to induce growth in the new build-to-rent single-family-home market. This market can build the new homes that local limits on apartment construction and national mortgage suppression have obstructed. We are poised to see real housing growth rather than rent inflation. It will largely come from build-to-rent.

I suspect that we are going to see a return to the pre-2008 scenario. Places with high real growth and places with inflation.

I’m not sure exactly what to do about it. (Well, the policy solution is to build more homes in the Closed Access cities, obviously.) Before 2008, this technical problem was probably less important for how the crisis played out than the national moral panic about mortgaged home buying was. And the Fed’s increasing motivation to aim for collapse became more important.

But, maybe this time will be the same, just with different characters. This time, the moral panic will be about institutional landlords buying homes.

I will be disappointed but not surprised if this is how it goes down. A build-to-rent building boom may be associated with some hot housing markets. Rent inflation will be high, nationally, with strong economic growth. It will be higher where homebuilding is lower and vice versa. That won’t matter. It will be blamed on the demand from “Wall Street” buyers.

Rent inflation will rise up when they are neutered. And the Fed might tighten into another recession after single-family build-to-rent construction is cut off.

I’m not sure that it could be nearly as bad as 2008 was. Most of the damage was from the mortgage tightening that created a wealth shock and knocked housing starts down by 80%.

I suppose if the big institutional landlords have to divest, and there aren’t any buyers left who can legally step in, home prices and construction could take a beating again.

I don’t know. I’m getting too far afield here. Focus, Kevin.

The first thing we need to consider is that the Fed is managing monetary policy for two economies - a low growth economy and an economy that has higher growth as a result of having an open relationship that takes the overflow from the low growth economy.

I think we might have some room to run where the high growth will be real. It will likely have to include a lot of build-to-rent single-family construction.

I think understanding this will be key to forecasts of Fed behavior and destructive public sentiment.

The 3rd quarter of 2006 to the 3rd quarter of 2007 was the first 1-year period where the Closed Access cities had higher employment growth than the rest of the country did (roughly coinciding with the inverted yield curve).

As of the first quarter of 2024, US employment growth was 1.8% while the Closed Access cities were 0.8%. So, we appear to be a long way from the danger zone. (And, I don’t think the current yield curve, properly interpreted, is inverted.)

Obviously, we should be wary of declining employment growth. But maybe also we should be wary of rising employment growth in the Closed Access cities, especially if it coincides with Fed concerns about a hot economy.

In the past, declining housing starts were a leading cyclical indicator. If housing production is mainly held low today by local land use regulations, mortgage suppression, and, currently, market supply chain constraints, then maybe housing will still be a leading cyclical indicator. But maybe the way a decline in the growth of housing demand per capita in our wounded economy will show up is as a rise in population and employment growth in the Closed Access cities.