Understanding Inflation

We recently received a very informative article by Megan Anderson, Vice President Public Relations at MBS Highway, we wanted to share with our partners and clients because it explains the complicated subject of inflation at a simple macro and micro level.

Macroeconomics is the study of the overall economy, including things like inflation, recessions, interest rates and economic growth. Microeconomics is the study of how macroeconomics change behaviors in individuals and businesses. 

Macro Level Inflation

Inflation is currently at a 40-year high for several reasons: increased government stimulus spending, supply chain difficulties with COVID-related port shutdowns, and pent-up demand.

Rates have moved higher in a very short period of time because of inflation.

This is how Megan explains what happens in real terms: “Imagine you have a fund and you’re lending money on mortgages out of that fund and you’ve given me a mortgage. I make a payment to you of $2,000/month. You take that $2,000 and you buy a list of goods and services. Now every month for the next several months, you purchase the exact same number of items on your list. But then over a little bit of time, you notice that you can no longer buy everything on your list. This is because inflation makes things cost more and as things cost more, you must leave some purchases off your list because the check you receive from me is for a fixed amount.

And while you can’t do anything about the loan you’ve already given me, what do you do to protect yourself from rising inflation on future loans?

You must increase your interest rate so you receive more than $2,000 on that same loan size to offset the more rapid loss of buying power, the more rapid erosion of that fixed amount that you’re receiving. And that is why as inflation rises, mortgage rates rise as well.”

Micro Level Inflation

Now let’s look at a potential home buyer. They are receiving a fixed salary or wage being paid every week, biweekly or monthly. They have a list of expenses for groceries, gas, bills, investments, entertainment, and more. When the cost of these items starts to rise due to inflation, they find they need to cut back on things they don’t consider necessities.

Your client may start to feel that buying a home is out of reach as they are feeling the strain of just paying for their basic needs, let alone saving up for the deposit.

That’s why it is key during times of inflation to understand all the loan programs available and to educate potential home buyers on all their options. Home ownership can equate to wealth generation and by moving to a fixed housing cost from inflation caused rent increases, over time, their discretionary spending will be increased.

You can see the comparison between renting and owning a home, over time, in the chart below.

How The Federal Reserve Fits In

The Federal Reserve is the central banking system of the US, created in 1913 with the purpose of having a central control of the monetary system to alleviate financial crises.

When inflation becomes rapid the Federal Reserve attempts to fight inflation and thereby rising prices by raising the Fed Funds Rate which is the overnight borrowing rate for banks. This means that certain loan types like car loans or business loans will cost the borrower more.

If you look at how this affects everyday lives, people may decide to forgo the new car and wait until they really need one. Saving also becomes more attractive as interest received will increase. With money sitting in accounts rather than being spent on goods and services there is a slow down in the rate money is changing hands.

Historically, a slowdown like this typically signals a contraction in the economy and may signal an oncoming recession. You can see below how this Federal Reserve action to fight inflation has typically led to recession.

What A Recession Means For Home Buyers

When we’re experiencing a recession, meaning economic activity is contracting, mortgage rates tend to decline as you can see below.

So, let’s think about the potential home buyer. It has been difficult for them to find a suitable home in the current market and now they are faced with increased mortgage rates and news media spreading recession fears. They might start to think they should wait on their home buying plans.

This is the time to let buyers know that regardless of current rates, in the not-too-distant future there will be opportunities to refinance at a lower rate and there is every reason to take advantage of the loan programs currently offered.

If potential home buyers are concerned the value of a home will go down during a recession the chart below will help to alleviate their fears. Home prices have done well during every recession with the only exception being the housing bubble from 2006 to 2008. That recession was caused by the housing bubble and we are not in the same situation today. We have low inventory of homes on the market, less new homes due to supply chain disturbances, and an increased demand from first-time home buyers.

All the indicators point to stable home price appreciation into the future.