Inflation is defined as too few goods chasing too many dollars.
Or better stated as — when the supply of money in circulation increases at a faster rate than the items purchased by those dollars, the dollar loses value.
The reason(s) inflation is upon us can be argued to a point. But the definition and the result are always the same.
Was our current rate of inflation due to Russia invading Ukraine, as well as the supply chain issues? Or was the multi-trillion-dollar stimulus, which increased the money supply by 40% in 1 year to blame?
Honestly, each of these had an impact as did many other factors. But shouldn’t the Federal Reserve (the Fed) have acted quicker to avoid such a steep increase in inflation? Yes, that fact is rarely argued. And since they didn’t act, they are now doing their best to catch up.
The Federal Reserve really only has 2 methods of reacting to inflation: being the federal funds rate (explained in a later section) and their balance sheet. These 2 mechanisms available to the Federal Reserve are extremely powerful. However, every move does have an impact on our economy and, in fact, the entire world economy.
If the federal reserve acts too slowly inflation can get out of control. Like it is now! But if they are hasty in their decision to change either the balance sheet or the federal funds rate, they may slow the economy way too early. That's almost as bad! In either case, our current inflation rate is 9.1% and likely to continue higher for several months.
The federal funds rate is the interest rate that banks receive for lending other banks overnight funds to maintain their required reserves on deposits. Banks with excess funds allow other banks that need funds to borrow at that said federal funds rate. Pretty simple!
But consider federal funds rate was 0% for quite a while. It's only now (July 2022) that we see the federal funds rate at 1.75% that's extremely inexpensive money. I wish we could borrow money at that rate. Oh that’s right, we could a year ago.
The Federal Reserve's balance sheet contains assets and liabilities. To gain assets in their balance sheet, they simply buy financial instruments such as mortgage-backed securities (MBSs). The Fed has been buying upwards of $90 billion in MBSs each month for quite some time. You can imagine their balance sheet is quite bloated with these.
Yet, that was one way for the Federal Reserve to help stimulate, support and continue the ongoing bolstering of our economy, particularly through the pandemic.
I know you're thinking, “Wow, thanks for the great lesson in Econ 101.” Well wait a minute, let's talk now about how the Federal Reserve can influence the economy and more to our point — housing.
The federal funds rate influences short-term interest rates. It has some suggestion on long term, but it doesn't really affect long-term interest rates like mortgages. But it does affect short term which stimulates or retards the economy today.
Let’s consider the Fed’s balance sheet.
They have been supporting the mortgage industry by buying mortgage-backed securities for quite some time. Now, if they reduce the volume of purchases or stop buying, the price of those MBSs will increase to attract institutional and private investors. If they then start balance sheet runoff or selling MBS’s, as well as, buying fewer mortgage-backed securities, this could drastically flood the market with MBSs and when supply increases, prices go down. Therefore, interest rates in the short term would increase.
And this is how the Federal Reserve tries to moderate our economy through these 2 levers.
Let's bring this into today's world and reference it to inflation.
Inflation is a 12-month running average of the consumer price index (CPI). As the current month falls off from last year this month replaces it. If this month is higher than the one that fell off 12 months ago, our inflation rate will be higher. For instance, last year CPI for June was 0.9%, this June (2022) 1.3%, causing inflation to rise from 8.6 to 9.1.
“Why?,” you may ask.
Well the definition of inflation is too many dollars chasing too few of goods.
The federal government issued lots of stimulus, increasing the total money circulation by 40%. Way too many dollars for the same amount of goods.
You can factor in the supply chain disruption that may have reduced goods too!
When you increase the money supply by 40% in one year, there's no way to keep inflation at bay. Note: 2 months of negative GDP (Gross Domestic Product) equals a recession. The National Board of Economic Research has to officially say we are in a recession, and they will if we have 2 quarters of negative GDP!
So does a recession mean that the bottom will drop out of the housing market?
Well if you watch the news you would say, “Yes, definitely.”
However, they sell doom and gloom. I like to deal with facts.
Fact – The United States has a demand of 4 million homes and a supply of 1.3 million. Not enough homes to go around. While the demand may in fact slow in our upcoming recession, the supply will slow as well. This will create an equilibrium, resulting in continued appreciation, continued sales (albeit slower turn around), but a housing bust is extremely unlikely. Remember, foreclosures are currently at 1% nationally.
Home prices are influenced by the economy for sure, but more buy real wages and supply. Also remember, that half of the 1.3 million homes available are actually in escrow and closing in 30 days or less.
But will anyone be able to buy a house in a recession? There are always many who suffer during an economic downturn. But there are also many who are still looking and buying homes.
The previous information does, however, speak to qualifying for financing.
As interest rates increase, most all payments increase. Wages increase as well but not as quick as Inflation.
Remember: you have 2 ratios in a mortgage — the front and back-end ratios. The front-end ratio is simply your mortgage payment divided by your gross monthly income. The back-end ratio is all debt added together and divided by your monthly income.
Generally, you need a 45% back-end debt to income ratio or less to qualify.
There are many types of loans so don't get discouraged if you try the math and it doesn’t appear to work! Simply talk to a professional mortgage originator and see if it's an option and/or if bank statements or DSCR, etc. are a better fit.
Lastly, a wise person once told me that the economy is always changing! It may be interesting to chat about and it’s always good to plan for the worst. But as long as you continue to do your part for your family and your sphere of influence, you're doing the right thing and you will be fine!
Plan ahead. Plan big and always have a path to achieve your goals!
Inflation is defined as too few goods chasing too many dollars.
Or better stated as — when the supply of money in circulation increases at a faster rate than the items purchased by those dollars, the dollar loses value.
The reason(s) inflation is upon us can be argued to a point. But the definition and the result are always the same.
Was our current rate of inflation due to Russia invading Ukraine, as well as the supply chain issues? Or was the multi-trillion-dollar stimulus, which increased the money supply by 40% in 1 year to blame?
Honestly, each of these had an impact as did many other factors. But shouldn’t the Federal Reserve (the Fed) have acted quicker to avoid such a steep increase in inflation? Yes, that fact is rarely argued. And since they didn’t act, they are now doing their best to catch up.
The Federal Reserve really only has 2 methods of reacting to inflation: being the federal funds rate (explained in a later section) and their balance sheet. These 2 mechanisms available to the Federal Reserve are extremely powerful. However, every move does have an impact on our economy and, in fact, the entire world economy.
If the federal reserve acts too slowly inflation can get out of control. Like it is now! But if they are hasty in their decision to change either the balance sheet or the federal funds rate, they may slow the economy way too early. That's almost as bad! In either case, our current inflation rate is 9.1% and likely to continue higher for several months.
The federal funds rate is the interest rate that banks receive for lending other banks overnight funds to maintain their required reserves on deposits. Banks with excess funds allow other banks that need funds to borrow at that said federal funds rate. Pretty simple!
But consider federal funds rate was 0% for quite a while. It's only now (July 2022) that we see the federal funds rate at 1.75% that's extremely inexpensive money. I wish we could borrow money at that rate. Oh that’s right, we could a year ago.
The Federal Reserve's balance sheet contains assets and liabilities. To gain assets in their balance sheet, they simply buy financial instruments such as mortgage-backed securities (MBSs). The Fed has been buying upwards of $90 billion in MBSs each month for quite some time. You can imagine their balance sheet is quite bloated with these.
Yet, that was one way for the Federal Reserve to help stimulate, support and continue the ongoing bolstering of our economy, particularly through the pandemic.
I know you're thinking, “Wow, thanks for the great lesson in Econ 101.” Well wait a minute, let's talk now about how the Federal Reserve can influence the economy and more to our point — housing.
The federal funds rate influences short-term interest rates. It has some suggestion on long term, but it doesn't really affect long-term interest rates like mortgages. But it does affect short term which stimulates or retards the economy today.
Let’s consider the Fed’s balance sheet.
They have been supporting the mortgage industry by buying mortgage-backed securities for quite some time. Now, if they reduce the volume of purchases or stop buying, the price of those MBSs will increase to attract institutional and private investors. If they then start balance sheet runoff or selling MBS’s, as well as, buying fewer mortgage-backed securities, this could drastically flood the market with MBSs and when supply increases, prices go down. Therefore, interest rates in the short term would increase.
And this is how the Federal Reserve tries to moderate our economy through these 2 levers.
Let's bring this into today's world and reference it to inflation.
Inflation is a 12-month running average of the consumer price index (CPI). As the current month falls off from last year this month replaces it. If this month is higher than the one that fell off 12 months ago, our inflation rate will be higher. For instance, last year CPI for June was 0.9%, this June (2022) 1.3%, causing inflation to rise from 8.6 to 9.1.
“Why?,” you may ask.
Well the definition of inflation is too many dollars chasing too few of goods.
The federal government issued lots of stimulus, increasing the total money circulation by 40%. Way too many dollars for the same amount of goods.
You can factor in the supply chain disruption that may have reduced goods too!
When you increase the money supply by 40% in one year, there's no way to keep inflation at bay. Note: 2 months of negative GDP (Gross Domestic Product) equals a recession. The National Board of Economic Research has to officially say we are in a recession, and they will if we have 2 quarters of negative GDP!
So does a recession mean that the bottom will drop out of the housing market?
Well if you watch the news you would say, “Yes, definitely.”
However, they sell doom and gloom. I like to deal with facts.
Fact – The United States has a demand of 4 million homes and a supply of 1.3 million. Not enough homes to go around. While the demand may in fact slow in our upcoming recession, the supply will slow as well. This will create an equilibrium, resulting in continued appreciation, continued sales (albeit slower turn around), but a housing bust is extremely unlikely. Remember, foreclosures are currently at 1% nationally.
Home prices are influenced by the economy for sure, but more buy real wages and supply. Also remember, that half of the 1.3 million homes available are actually in escrow and closing in 30 days or less.
But will anyone be able to buy a house in a recession? There are always many who suffer during an economic downturn. But there are also many who are still looking and buying homes.
The previous information does, however, speak to qualifying for financing.
As interest rates increase, most all payments increase. Wages increase as well but not as quick as Inflation.
Remember: you have 2 ratios in a mortgage — the front and back-end ratios. The front-end ratio is simply your mortgage payment divided by your gross monthly income. The back-end ratio is all debt added together and divided by your monthly income.
Generally, you need a 45% back-end debt to income ratio or less to qualify.
There are many types of loans so don't get discouraged if you try the math and it doesn’t appear to work! Simply talk to a professional mortgage originator and see if it's an option and/or if bank statements or DSCR, etc. are a better fit.
Lastly, a wise person once told me that the economy is always changing! It may be interesting to chat about and it’s always good to plan for the worst. But as long as you continue to do your part for your family and your sphere of influence, you're doing the right thing and you will be fine!
Plan ahead. Plan big and always have a path to achieve your goals!
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