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The money illusion and housing prices

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This story (gift link) in the New York Times does discuss a real problem — entry-level homebuyers in the US are currently struggling with the consequences of rate lock — but it does so in a way that wildly exaggerates the housing affordability issue, because it exploits, intentionally or not, the money illusion.

The money illusion is the universal tendency of people to fail to adjust nominal prices for inflation, which is probably the single biggest reason why higher than average inflation itself is such a massive political liability for presidents etc.

Rate lock is what happens when mortgage rates rise rapidly over a short period, meaning that many potential sellers are deterred from selling and many potential buyers are deterred from buying, because so many people have much lower mortgage rates locked in than the rates they would have to pay if they sold their present houses and bought replacement properties. Econ 101 says prices should decline to compensate for this effect, but quite the opposite has happened over the last couple of years, which is why we have Econ 201 et. seq.

So it’s an actual problem at the moment. But the stats quoted in the article give the impression that housing prices in the US have more than doubled over the past 20 years. This is sort of true in nominal terms, but completely untrue in real, inflation adjusted terms, thus creating an impression of a crisis that is much more extreme than the actual problem of housing affordability, which of course is real, but greatly exaggerated by exploiting the money illusion.

Specifically, the median price of a single family home in the US increased by 19% in real dollars between the first quarter of 2004 and the first quarter of 2024. That’s not great, but the national average wage index increased by 14.5% between 2004 and 2022, while the median hourly wage increased by 9%. Given that wages have increased faster than inflation the past couple of years, the median price of a single family home in the US is barely higher, if at all, in terms of affordability, than it was 20 years ago, once you strip out the money illusion.

I know this is very counter-intuitive, especially if you live in an area where housing prices have gone up much faster than average, but of course that means that lots of people live in areas where housing prices have gone up much more slowly than average (per the article, the median price of a house in Cleveland is currently less than $200,000 for example). ETA: Denverite in comments makes the good point that journalists for national publications tend to live in places where housing prices have gone up much faster than the national average. BTW Boulder housing prices have more than quadrupled in real terms since 1990.

I realize this is something of a pedantic quibble, given that there is a housing affordability problem across the US for various reasons, but it’s not helpful (especially to Joe Biden’s re-election chances) to greatly exaggerate the actual problem by using nominal rather than real prices when discussing that problem.

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