The housing bust, adjusted for inflation

In the inflation-adjusted version, housing prices peaked in December 2005 and they've declined 16.6% since then, bringing us back to the level of early 2004. So we appear to be substantially farther into the housing slump in real terms than in nominal terms. Which might actually be a good thing.

"If they could generate enough inflation," economist Ken Rogoff told me last week, "I guess the Fed could make the house price problem go away." What he meant was that, if we had double-digit inflation, house prices might stop going down in nominal terms. He did not mean this as a serious policy suggestion.

But the Fed is tolerating 3% to 4% inflation, and that's making the impact of the housing decline less dramatic than it would otherwise be. It's the real (inflation-adjusted) price that counts when you're talking about housing affordability. It's the nominal (unadjusted) price that matters to borrowers and lenders. We need a real housing price decline to get prices back in line with incomes and rents. But if we can inflate our way out of a little bit of the nominal house price decline, we reduce the risk of economy-paralyzing insolvency problems in the financial sector. (Just ask Irving Fisher.)

Now inflating just a little bit can be hard to do. The Fed is clearly playing with fire here. But hey, without fire, our civilization wouldn't amount to much.