Many of the opponents of the Republican tax cuts predicted a wide range of disaster scenarios if the tax cuts passed. Most of these were unrealistic. Tax cuts directed primarily at the wealthy were not a good use of government money, but they were not going to collapse the economy.
Nonetheless, there were some predictable negative results, at least one of which seems to be coming true. To date, it appears that consumer demand resulting from the tax cut (not the promised investment boom) is leading to more rapid growth than would otherwise be the case.
Because the Federal Reserve Board has chosen to raise interest rates at least partly in response to this acceleration of growth, the housing market appears to be weakening. Surprisingly, this fact seems to be getting little attention from either the mainstream media or the most ardent opponents of the tax cuts.
The lack of attention is a bit surprising since the impact on housing is pretty much a textbook story of why a larger budget deficit — whether due to a tax cut or spending increase — could be bad for the economy. The story is that a larger deficit increases demand in the economy. Other things equal, this puts upward pressure on interest rates.
The Fed can accommodate this demand and keep long-term interest rates from rising. However, if the economy is near its potential level of output, this would risk inflation.
Alternatively, the Fed could let interest rates rise or even push them higher through its own actions. The Fed has clearly adopted this latter course. As a result, long-term interest rates have risen. Currently, the 10-year Treasury bond rate is just over 2.8 percent.
While this is still a very low rate by historical standards, it is about 0.6 percentage points higher than the rate a year ago. This has translated into a comparable increase in the 30-year mortgage rate. It now stands at close to 4.2 percent, as opposed to 3.6 percent a year ago.
As would be expected, higher mortgage rates appear to have weakened the housing market. Existing home sales have been edging downward most of this year. They peaked at an annual rate of 5,050,000 in November of 2017. The data for July sales released last week showed them at 4,750,000.
There is a comparable story with housing starts. The data on housing starts (and sales) are erratic, but the July data showed starts down by 1.4 percent from their year-ago level. The average annual rate for starts over the last three months has been 1,215,000. That compares to an annual rate of 1,317,000 in the first three months of the year.
This is potentially a big deal because housing costs are the one area where inflationary pressures are clearly a problem. This matters not only because rising rents are pushing up the overall rate of inflation, but rent is by far the largest single expenditure for low- and moderate-income households. With rents rising more rapidly than other prices, and more rapidly than wages, many families are finding it increasingly difficult to make ends meet.
The best hope for bringing rents down, or at least slowing their rate of increase, is by rapidly increasing the supply of housing, thereby putting downward pressure on rents. However, with construction slowing, there is not likely to be much relief any time soon for most of the areas where housing costs are a major problem.
It is worth mentioning that this is at least partially the Fed’s fault. The Fed could have acted to limit the rise in mortgage interest rates. Instead, it continued to raise short-term interest rates, presumably because it feared inflation.
While the Fed can be criticized for this decision, there is no doubt that the faster growth resulting from the tax cut is a big factor in its decision to raise interest rates. And, this was an outcome that was 100 percent predictable at the time of the tax cut.
For this reason, it is surprising that the weakening of the housing market has not received more attention. As noted before, the monthly data are erratic, and we have only a limited time period to look to, but at the moment it certainly appears as though the tax cuts have made the country’s housing shortage worse. Higher rents for low- and moderate-income households is not a good story.
Dean Baker is co-director of the Center for Economic and Policy Research in Washington, DC. Dean previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. He has also worked as a consultant for the World Bank, the Joint Economic Committee of the U.S. Congress, and the OECD's Trade Union Advisory Council.
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