To repeat, the key shift in perspective is to understand that modest, steady increases in (nominal) income are always good. Given steady increases in nominal income, inflation is always bad. 3% growth + 2% inflation is better than 2% growth + 3% inflation, and it doesn’t matter whether you’re a debtor or not.
Inflation helps RICH people with debt because their debt is backed by an asset. If the asset increases with inflation and the debt does not, that can be hugely valuable.
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Don’t most people have mortgages now below 3 percent? I know mine is something like 3.125, and it always seems higher than other people’s mortgages. I just haven’t bothered refinancing because we only have a few years left. I think inflation could easily stay around 3 percent for an extended period.
I would say it helps rich people more, for the reason you state. But it can theoretically help anybody, because if wages keep up with inflation, the debt payment as a percent of monthly income can become insignificant, or at least less significant.
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The “always” in this sentence is not quite right. You can actually test this out in a spreadsheet - I built a simple spreadsheet with the following inputs:
I = Year 1 household after tax income
E = Year 1 household expenses excluding mortgage
M = Year 1 mortgage balance
H = Year 1 market value of house
w = wage inflation rate
i = price inflation rate
m = mortgage rate
If you make some broads simplifying assumptions like I grows at w% per year, E and H grow at i% per year, M grows with m% per year but is reduced by (I - E) (i.e. assume they pay all their surplus cash flow to the mortgage) then you get some really interesting outcomes. Using the w and i in your post (2% and 3%, flipped around for different scenarios) you will find that different combinations of I, E, M, and H result in different net positions after 20 years. Families with large M and H relative to I and E will benefit from the inflation scenario. When inflation outpaces wage growth for them they lose net cash flow, but the real value of their net position is a positive because the equity in their home grows in real terms.
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But shouldn’t the value of the house increase by w + i? If the economy’s growing, you’d expect real estate to get more valuable.
EDIT: To put it another way, it depends on what you hold fixed when you talk about whether you want inflation higher or lower. If nominal income growth is fixed by the monetary authority, then the tradeoff is between more real growth and more inflation. Growth is good, which means inflation is bad. By contrast, if you hold real growth constant, the tradeoff is between nominal incomes growing less than normal or inflation being higher than normal, which means inflation is good, at least sometimes.
Assuming a competent Fed, which we seem to finally have, the first perspective makes infinitely more intuitive sense. When something bad happens (like a global pandemic), wages go up, but inflation goes up too, people are sad, etc. When something good happens (productivity boom), wages still go up, but prices stay the same, people are happy, etc. But the good things for people are: 1) you get paid more, which means you can cover your fixed expenses more easily, and 2) maybe prices don’t rise enough to claw back your increased spending power. But (1) is good even if prices do claw back your real spending power, and (2) is always bad after you have (1).
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Futures are all down sharply today, which means most likely we will have a nice 1 percent plus broad based gain.
Did you mean to say “inflation is not always bad”?
No. Inflation is worse than everything except nominal incomes growing more slowly than trend.
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I would say deflation is worse than inflation too.
Maybe? That’s kind of the point, there are actually many ways that wages and inflation and housing prices and interest rates and stock returns and taxes can all change relative to each other. That’s why there are no definitive statements that inflation is always good or always bad. There are too many moving pieces.
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i do agree that the extended period of mortgage rates staying around 3-5 (depending on fixed term/arm) was contributing to inflation staying around 2 in the same timeframe. housing is like 40% of core inflation. and those who locked in 30yr fixed are netting the difference during any one year that inflation is 6% (assuming they get a raise) but on average the rates are higher than inflation over the term. if let’s say cpi shows 6% next year too, there aren’t going to be any mortgages available at 3, right?
This is probably surprisingly difficult to determine. The most likely scenario would be persistent inflation drives monetary policy changes with Central Banks increasing interest rates, and mortgage lenders responding with higher lending rates. But I think that middle step has to happen. Theoretically, if inflation persists at high levels and central banks don’t increase interest rates, then banks probably wouldn’t increase mortgage rates. They’d still be able to lend at a profit.
Deposits are probably going to keep paying 0%, so won’t lenders happily continue making 3% mortgage loans?
Canadian banks tend to move their mortgage rates with the central bank overnight rate, not deposit rates, although they are all related. If central banks tighten monetary policy and increase the overnight rate then maybe/probably deposit rates will follow.
Banks have capital requirements. If they invest deposits in the stock market, they can’t count those assets as assets of the bank when reporting to regulators on their reliability as a financial institution.
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Banks can’t take that much risk, if their assets decline in value by anything approaching normal equity volatility they’re wiped out. Also banks generally don’t hold mortgages, they sell them instantly (ideally for a profit, known as gain on sale).
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Also, even if banks were allowed to do this, shareholders might wonder why they are giving capital to someone else to invest in the market for them. Shareholders invest in Banks to capture borrowing/lending spreads. If they want to capture borrowing/SPY spreads they can do that themselves.
I honestly don’t know who is buying mortgage bonds but my gut tells me its massive institutions that are liability matching (including the Fed).
You’re looking at return on investment, they’re looking at risk-adjusted return. The return is low because the risk is low.