Apartment Inflation

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John Cochrane
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Summary

  • Apartment rents are a classic "sticky price;" the rent is fixed in dollar terms for a year.
  • So, landlords decide how much rent to charge, and people decide how much they're willing to pay, balance rents now vs. higher rents in the future.
  • Inflation should not be a surprise to forecasters. If you see rents on new leases much above average rents, it's a pretty good bet that average rents will be rising in the future.

Red Percentage sign on facade background of new residential building. Interest rates. House Share. Real estate investing. Buy, sale, rental and insurance apartment in crisis. Mortgage. Forecasting.

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Apartment inflation

This beautiful graph comes from calculatedriskblog.com. (Courtesy Andy Atkeson who used it in a nice discussion of a great paper by Ivan Werning at the Minneapolis Fed Foundations of Monetary Policy conference.)

The central lines that don't move so much are the average rent. This is the quantity used by the Bureau of Labor Statistics to compute the consumer price index. The blue and yellow lines are the rent of new leases.

The first thing this informs is the economic theory of "sticky prices." Apartment rents are a classic "sticky price;" the rent is fixed in dollar terms for a year. So, landlords deciding how much rent to charge, and people deciding how much they're willing to pay, balance rents now vs. higher rents in the future. If everyone believes that inflation will be 10% over the next year, then it makes sense to raise the rent 5% now, and to pay the 5% higher rent, because the savings at the end of the year balance the cost in the beginning. (Obviously, the economics are much more subtle than this, but you get the idea.) And Voila', you see it.

The graph also says there is some predictability and momentum to inflation. Inflation should not be a surprise to forecasters. If you see rents on new leases much above average rents, it's a pretty good bet that average rents will be rising in the future! This kind of phenomenon may be under exploited in formal inflation forecasting.

And, on the continuing speculation whether inflation will go away with interest rates still substantially below current inflation, the graph does seem a leading indicator that the rational expectations model is winning.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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John Cochrane profile picture
679 Followers
John H. Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. His recent finance publications include the book Asset Pricing, and articles on dynamics in stock and bond markets, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing when investors can’t perfectly hedge. His monetary economics publications include articles on the relationship between deficits and inflation, the effects of monetary policy, and on the fiscal theory of the price level. He has also written articles on macroeconomics, health insurance, time-series econometrics and other topics. He was a coauthor of The Squam Lake Report. He writes occasional Op-eds, and blogs as “the Grumpy Economist” at johnhcochrane.blogspot.com. Cochrane is a Research Associate of the National Bureau of Economic Research and past director of its asset pricing program, a Senior Fellow of the Hoover Institution at Stanford University, and an Adjunct Scholar of the CATO Institute. He is a past President and Fellow of the American Finance Association, and a Fellow of the Econometric Society. He has been an Editor of the Journal of Political Economy, and associate editor of several journals including the Journal of Monetary Economics, Journal of Business, and Journal of Economic Dynamics and Control. Recent awards include the TIAA-CREF Institute Paul A. Samuelson Award for his book Asset Pricing, the Chookaszian Endowed Risk Management Prize, and the Faculty Excellence Award for MBA teaching. Cochrane currently teaches the MBA class “Advanced Investments” and a variety of PhD classes in Asset Pricing and Monetary Economics. Cochrane earned a Bachelor’s degree in Physics at MIT, and earned his Ph.D. in Economics at the University of California at Berkeley. He was at the Economics Department of the University of Chicago before joining the Booth School in 1994, and visited UCLA Anderson School of Management in 2000-2001. In addition to research and teaching, Cochrane is a competition sailplane pilot and windsurfs. He lives in Chicago with his wife Elizabeth Fama and children Sally, Eric, Gene and Lydia. For more information, please see Cochrane’s website, http://faculty.chicagobooth.edu/john.cochrane/

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