What 1% inflation means for housing in the Twin Cities

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As of July, inflation in the Twin Cities over the past year was 1%. That was one of the lowest rates for any metropolitan area in the country and led to a bit of a victory lap when the national media featured our region. Filling out this story, a number of observers tied this low inflation rate to a local housing market producing housing at a high rate, which naturally gives us a sense of pride. Is that sense of accomplishment deserved? Yes and no.

We agree that housing production should be the focus today and in the future, but it's way too soon to declare victory.

Before making our case, we should be clear about what inflation is and is not. Inflation is the rate of change in prices for the "basket of goods and services" — that is, for the things we buy. It is not a measure of how expensive the items in the basket are. For instance, when the cost of a new car (whether it is a base model or fully loaded) rises over time, car-price inflation is positive. If the cost stops rising, car-price inflation would be zero, even though the car is more expensive than it used to be.

In terms of the "yes" part of the argument, two clear facts justify seeing housing as an explanation for our low inflation.

First, housing production is, in fact, up. The Itasca Project — an employer-led civic alliance focused on prosperity for all — has set housing production goals for our region. The group argues that the Twin Cities region should produce at least 18,000 housing units annually in order to keep pace with household growth, erase the deficit of production left by the Great Recession and provide enough cushion in housing supply to slow the rise in housing prices. The good news is that production has exceeded this goal each year since 2019. As the Regional Housing Affordability Dashboard that we developed with the Itasca Project shows, production reached a record of 22,570 units in 2021.

Second, housing prices are actually rising here at a lower rate than in the rest of the country. Housing (technically called "shelter") is by far the biggest single item households purchase and makes up about one-third of the basket. While inflation is 1% in the Twin Cities, it was 3.2% in the nation as a whole. (There are several measures of inflation; we are talking about inflation over the last 12 months measured by the "headline" Consumer Price Index.) About half of the difference between inflation in the Twin Cities and inflation in the nation is accounted for by the fact that housing prices are growing slower here than in the nation as a whole. Housing prices are rising about 4% in the Twin Cities and almost 8% in the country overall.

But stopping with these two points is premature and could even create a false sense of complacency when it comes to housing policy and focus.

At the most basic level, housing production isn't the sole driver of lower inflation compared with other regions. Non-housing items in the basket account for the other half of the difference in inflation between the Twin Cities and the rest of the United States. There is no specific non-housing item that drives this result; our prices are rising slower pretty much across the board. So even if housing prices rose as fast in the Twin Cities as they have in the rest of the country, our inflation would still be lower here. And, historically, the Twin Cities has had periods when our overall inflation is lower than in the rest of the country even when our housing inflation has actually been higher than in the rest of the country.

There is a second reason to not rest on our laurels. To meet the Itasca Project housing production goal, the region must continue building more housing at the same pace we saw earlier in the pandemic.

In a related point, we are not outperforming our peers. In fact, we are just in the middle of our peer group, behind cities like Austin, Charlotte and Dallas. And being ahead of San Francisco and Boston — two expensive housing markets — should not bring us much satisfaction.

Finally, we seem to be falling behind other states that are taking steps to ensure that the market has a fighting chance to produce the housing that meets residents' needs. Minnesota has taken important actions to subsidize the production of more affordable housing. That will prove valuable for our lowest-income residents, because the market alone cannot generate new housing priced at levels they can afford.

It is overall production, not only subsidized production, that determines the long-run price of housing. A recent survey of state actions finds that 10 states, including states as varied as Maine, Montana and Washington, have taken important steps to increase overall production now in order to keep prices lower in the future. The lower-cost housing that we will want to preserve in the future will start off as new construction today. And we should certainly not take government actions that will reduce supply in the long run.

So, we should be satisfied that our price growth is lower than in the rest of the country and in other cities. And more housing is part of that story. However, we should not think we have reached the destination. We need a continued focus on more production. And where we can take policy actions to support building more to keep prices down, we should.

Ron Feldman is first vice president and chief operating officer of the Federal Reserve Bank of Minneapolis, and co-chair of the Itasca Project Housing Task Force. Alene Tchourumoff is senior vice president of community development and engagement for the Minneapolis Fed and is a member of the Itasca Project Working Team.