How Does The Rising Rate Of Inflation Bring Down The Prices Of Houses In The United States - Essay Example

?Macroeconomics - Housing and Inflation Table of Contents Table of Contents 2 Research Question: How Does The Rising Rate Of Inflation Bring Down ThePrices Of Houses In The United States? 3 References 12 Bibliography 14 Research Question: How Does The Rising Rate Of Inflation Bring Down The Prices Of Houses In The United States? When the prices of all the goods and also services increase continuously, this activity is known as inflation. During a period of inflation money loses its power of purchasing since every unit of currency buys less amount of goods (Cedar Spring Software, Inc., “Price Inflation”). Although inflation occurs regularly in the economic system, it becomes a matter of concern when it reaches at higher levels. The rate of inflation provides the measure of price changes which occur for many goods and services. When it comes to individual goods, the changes in the prices vary greatly. The prices of number of goods such as gasoline, health care, housing and automobiles have significantly increased during the last decades. On the other hand, the prices of the commodities such as computing power and calculators have decreased. Different methods are used to measure the inflation rate (Kaplan,”Inflation”). The most common approach to measure inflation in US is Consumer Price Index (CPI) which includes the following steps: Though the measurement of all goods is generally complex it is not an impossible task. The goods such as transportation, housing, food, communication and others are designated by specific goods i.e. ‘market basket’ whose changes in the price can be calculated accurately over time. In the market basket the individual items are weighted against their relative importance. For example, gasoline price will obtain more important weighing compared to the price of tomatoes due to the fact that a greater percentage of budgets are spend on fuel. The individual item’s price and their respective relative weights are then used to calculate Consumer Price Index (CPI) (Kaplan, ”Inflation”). The US CPI reflects the national income accountability treatment of the houses occupied by the owner. There is an assumption that owners rent their homes from themselves, thereby creating a category which is called Owner-Equivalent Rent (OER). Since two-thirds of households in the US or even more have possession of the houses that they reside in, the weight of Owner–Equivalent Rent in the CPI is significant; it accounts for around 23.8% of headline CPI and around 30.8% of the traditional core CPI which excludes energy and food. The rents languished due to an increase in the sale price of houses in the recent years. Since the year of 2000, it can be found that OER has increased approximately 26% while the government’s price index of existing homes has increased 80%. This indicates that the sale prices of existing homes and new homes rose by 5% or even more per year faster than rents since the twist of the millennium (Cecchetti, “Housing in Inflation Measurement”). Consumer Price Index Levels (1950-2003): Source: (Cedar Spring Software, Inc., “Price Inflation”). The above chart indicates how the effects of continuous inflation build up over the years. It consists of the index values of CPI for the month of December of each year. The value of index of 180 indicates that prices have risen 80% which is measured from a “base of 100”. With the help of index values, one can determine that goods and services which cost $3,000 at the end of the year 1992 will cost $3,897.00 at the end of the year 2003. The supposed household cannot wait for the inflation to be at a normal level. They must make sure that their interest and income keep pace with the long-term inflation or else they would become poor (Cedar Spring Software, Inc., “Price Inflation”). Percent Changes in Inflation (1950-2003): Source: (Cedar Spring Software, Inc., “Price Inflation”). The above chart depicts changes in the inflation rate and not the actual price changes. A line that trends downward which is above zero indicates that the prices are still rising but at a lower rate. At times it can be called as deflation even though this is inflation. When the rate drops below zero, as it had done in the year 1954, it can be observed that the average prices are actually falling (situation of deflation). While prices that are low may seem perfect in the beginning from the point of view of consumer, deflation leads to increasing unemployment and diminishing production, a condition from which it is quite hard to improve. According to many economists the rate of inflation of 1% - 2.5% presently seems to be suitable. Since rate of inflation is an average of all prices, it may be at variance noticeably from the rate practiced by any one particular household. Since each household will exhibit different quantities and types of items in their "market basket", the rate of inflation will vary accordingly (Cedar Spring Software, Inc., “Price Inflation”). Source: (Capital Professional Services, LLC,” Recent Inflation History”). In the mid of the year 2002, when the recession was at its depth, the rate of inflation through its moving average crossed back up, indicating that the period of deflation has come to an end leading to an increase in the inflation. It is indicated by brown lines. Due to the fact that central bank was raising the supply of money, the rate of inflation had started “a six year up trend” along with the rise in the consumer prices. The oil spike was following the Katrina spike which had brought the rate of inflation to an ‘artificial high’ that was based on the supply factors and not the monetary factors leading to fall in the prices of the oil which further led to fall in the rate of inflation for the purpose of returning the system to balance so that it could fit the linear regression line.   In the above figure, the blue trend-line represents a “Linear Regression" line indicating the trend for the entire period. It can be further seen that the trend in the chart over the period i.e. since 1990 is declining to certain extent. The Blue line tilting downwards indicates this. It can be further noticed that the relationship between the rising prices of energy and food drove the rate of inflation to increase up to 5.6% in mid-2008 and then as the rupture of Oil bubble took place, it started the downward trend. Finally the stock market and the housing market had gone down, thereby reducing the supply of money and creating a crisis of liquidity, thus sinking the US into a deflationary period where the prices were in fact lower than 2008, reaching a deflationary short of -2.1% in the month of July of the year 2009. Since that time inflation moved up owing to the Trillion Dollar stimulus but again it started falling. The average annual rate of inflation since the year 1913 has been 3.41% for the entire duration per year (Capital Professional Services, LLC,” Recent Inflation History”). Inflation-Adjusted House Prices: Source: (Housing Bubble Graphs, “Inflation-Adjusted House Prices”). Nominal House Prices Compared To Owner-Equivalent Rent: Source: (Housing Bubble Graphs “Inflation-Adjusted House Prices”). In the month of January, 2008 the rate of inflation in the US increased. According to the Labor Department, the prices of the producers rose by 1% in January 2008 on increasing energy costs. According to Standard & Poor, there was a decrease of around 8.9% in the existing homes of single family of the US. According to S&P/Case-Shiller, composite index which was of 10 metropolitan areas dropped by 2.3% in the month of December, 2008 as against November, 2008 which was 200.55, and dropped by 9.8 % year-over-year. It was considered as the largest decline in the twenty year history of a national price index of home. For a number of 20 metropolitan areas, the composite index dropped by 2.1% to 184.86 in the month of December, 2008 from the month of November, 2008 leading to a year-over-year drop of 9.1% (The New York Times Company, ”U.S. Inflation Soars; Housing Prices Plunge”). The Federal Reserve has publicized no desire to increase the US inflation rates prior to generating more employment opportunities and until the slow improvements are on a firmer grip. As a result the super-cheap money of Federal Reserve is taking some of the fault for fueling the product explosion that is further adding to pressures of inflation (Wheatly & Mutikani, ”U.S. Inflation Contained, Bucks Global Price Trend”). References Capital Professional Services, LLC.” Recent Inflation History”. April 25, 2011. Home, 2011. Cedar Spring Software, Inc. “Price Inflation”. April 25, 2011. Get Objects, 2004. Cecchetti, Stephen. “Housing In Inflation Measurement”. April 25, 2011. Home, 2007 Housing Bubble Graphs. “Inflation-Adjusted House Prices”. April 25, 2011. Nominal House Prices Compared To Owner-Equivalent Rents, 2011. Kaplan, Jay. ”Inflation”. April 25, 2011. Inflation and Economic Growth, 2002 The New York Times Company. ”U.S. Inflation Soars; Housing Prices Plunge”. April 25, 2011. The New York Times, 2008 Wheatly, Alan. & Mutikani, Lucia. “U.S. Inflation Contained, Bucks Global Price Trend”. April 25, 2011. International, 2011. Bibliography CoinNews Media Group LLC. “Inflation Calculator: Money’s Real worth over Time”. April 25, 2011. Home Page, 2011. Samet, Abel. The Tale of Two Booms: Do Housing Prices Explain Excessive U.S. Consumption? April 25, 2011. Washington University in St. Louis, 2009. U.S. Bureau of Labor Statistics. “Consumer Price Index”. April 25, 2011. Subject Areas, 2011. Read More