And if inflation is hidden in Financial Assets and Real Estate ?
The current level of inflation is raising fears of a deep crisis or of a disturbance of our economies. Cyclical factors explain its high inflation levels such as, for example, shortages of spare parts, surges in commodity prices due to (energy in particular) or even the increase in the costs of maritime transport, etc. leading specialist to suppose a temporary inflation.
But a sudden high inflation appears to be unexpected if we consider that before covid-19 inflation level was under target and relatively low despite a decade of unconventional monetary policy.
Inflation sources are multiple but depend to Economic Fundamental (shortages, wages, growth etc) and also Monetary Policy (regulating the money quantity). Generally speaking, Inflation is defined as “Price Increase of consumer goods” but it is only a consequence of a more complex phenomenon.
What is Financial Assets Inflation?
Inflation is measured either by consumer prices (CPI) or factory prices (PPI). However, these methods forget to include several service and goods in their baskets. However, Financial assets and Housing prices fluctuation are not included in the scope of Inflation while being important factors in economic stability. Houses spending’s represents an important part of household’s expenditures and so conditions the purchasing power and Financial Assets (like Bonds or Stocks) are main Savings tools (pension, mortgages etc …). In the past decade, the 2008 crisis and today with Evergrande case are best example of the impact of Real Estate and Finance on economic uncertainty and crisis.
The Financial Assets Inflation (FAI) appears when prices of financial assets continuously inflate. The sources of FAI are depended to the assets of interest.
Traditional Financial Assets like Bonds and Stocks are drive by Economic Fundamental, Monetary Policy and also speculative behaviors (compare to economics fundamentals). Real Estate Prices are also affected by multiple factors on local economic situation, geographical localization etc … but Monetary policy (access to loans etc …) and financial aspects are more and more important as the sector tends to be financialized. In this case, Real Estate are both a Goods related to a need and a financial asset useful to invest.
Central Banks through multiple channels can affect both value of Financial Assets and Housing. Interest rate level affect both value of bonds, and then prices stocks (risk premia etc …). But Financial assets stability is not the objective of major central banks only Consumer Inflation are targeted … then there are not methods to properly quantify FAI.
In addition, the notion of FAI is closed to the concept of Bubble. By definition, a bubble is excessive prices increase above a theoretical level. Then, FAI could be first sign of the creation of a bubble.
In this case, standard financial approaches show historical patterns in financial ratio like P/B or CAPE (Cyclical Adjusted Price-Earning Ratio, or Schiller Ratio) useful to identify bubble-like behaviors. Historical evolution highlights that ‘’speculative bubble’’ burst when CAPE are hight or above an historical level over X years (5 or 10 yrs).
In Real Estate Sector similar observations are made, prices of housing tend to strongly increase in ‘’ expansion period” but continue when first sign of a slowdown appears. Finally, houses price collapse in economic recession. Some works study the possible role of Real Estate sector in creation of economic instability as these sector are related to Banking (with mortgage loans) , Industry (raw material) and causes many direct employments.
Some questions arise as measuring FAI is, in fine, equivalent to determine when prices movements in financial markets and property sector are excessive or too high … and then discuss on possible regulation of these sectors.