The US housing shortage has profound economic consequences. Less discussed is the fact that it is slowing down the US climate transition. Many regions of the United States, especially California and New York, are failing to build dense urban housing which is associated with lower emissions. But there is another, indirect way that the housing shortage is sabotaging efforts to decarbonize the US economy. Inadequate housing is stimulating inflation and lifting interest rates, which hurts the economic viability of clean energy projects.
California, New York, and other states should move heaven and earth to authorize and construct new housing rapidly, especially in dense urban areas. If these states and others prioritize building houses, emissions and interest rates could fall substantially, providing a major economic and climatological boost to the United States.
The US housing shortage
Like all prices, elevated housing costs are a symptom of supply and demand.
Housing demand surged amid the pandemic and shifting office routines. With Covid-19 constraining mobility, individuals working from home upsized into larger dwellings suitable for full-time remote work.
The housing problem is on the supply side: the United States is not building enough housing.
From 2012 and 2022, the gap between household formations exceeded national home constructions by 2.3 million homes.
While many places have underbuilt housing, it’s worth highlighting the abject failure of two large and important states: California and New York. The nation’s largest and fourth largest states by population have failed to match the housing construction pace of Texas and Florida, the nation’s second-largest and third-largest states, respectively. In 2023, Florida and Texas together authorized three times more housing than California and New York combined.
The situation is even more stark after normalizing for population. California and New York’s per capita homebuilding rate actually declined from 2019, while Florida and Texas’ rose slightly despite a much less favorable interest rate environment.
Why have California and New York failed to build housing? As John Burn-Murdoch identified in a trenchant analysis for the Financial Times, these states’ planning systems place artificial restrictions on supply.
California and New York’s permitting processes are in shambles, largely due to state and local dysfunction. In San Francisco’s infamously restrictive housebuilding environment, it usually takes two years to fully approve a housing development, without even taking construction time into account. New York state legislators, meanwhile, blocked tax and zoning changes that would have allowed for more new large apartment buildings.
Due to insufficient housing supply, California and New York are, unsurprisingly, deeply unaffordable compared to other markets that are constructing housing. The burden of these failed policies disproportionately affects the young and individuals of color.
Housing accounts for about one-third of a median household’s budget. But costs are even higher for younger individuals: in 2022, half of all householders aged 15-24 spent 35 percent or more of their annual household income on rental costs.
Similarly, individuals of color are particularly impacted by higher rental prices. Black and Hispanic Americans have home ownership rates of 44 percent and 51 percent, respectively, while white Americans have home ownership rates of 72.7 percent.
How housing prices affect inflation—and the cost of clean energy
Rental prices rose 22 percent from December 2019 to December 2023, higher than the 18.4 percent rate of inflation if shelter is excluded. Consequently, renters have experienced higher rates of inflation. Expanding housing supply could therefore have a positive impact on renters.
US inflation today is largely a housing phenomenon, as shelter now accounts for over two thirds of the rise in the US core consumer price index (CPI), which excludes volatile food and energy prices and is a useful proxy for tracking consumers’ out-of-pocket spending and inflation-adjusted wages. Moreover, real-time measures of shelter costs, such as Zillow’s Home Value Index, show that prices rose 3.6 percent year-over-year in February 2024. (Housing represents a smaller share of the Fed’s preferred inflation measure, the Personal Consumption Expenditures Index, but even there it’s a major chunk of the total.)
With housing shortages contributing to inflation, the Federal Reserve has been forced to impose higher interest rates. High interest rates are disastrous for US climate goals, as capital-intensive clean energy projects benefit from lower financing costs and are penalized by higher rates. If interest rates rise to 7 percent from 3 percent, the cost of offshore wind and solar farms rises by about one-third, nuclear energy costs grow by even more, but natural gas plant prices barely budge. Unsurprisingly several US clean energy projects, from nuclear to renewables, have faced cancellations due to higher-than-expected interest rates.
As inflation abates, central banks will be freer to lower interest rates, reducing financing costs for clean energy projects. Expanding housing would therefore not only provide a sizable economic boon to the United States, producing a virtuous cycle of lower interest rates for longer, but also deliver progress on climate.
Dense housing is good for climate mitigation
Insufficient housing, especially dense urban housing sited near transit, also carries huge climate consequences. Per-capita greenhouse emissions are much lower in urban neighborhoods than other areas.
New York and California are not only failing to build a sufficient quantity of housing stock, but also to build sufficiently dense units. In California, dense housing stock is facing an array of challenges, especially at the local level. Although New York’s home building is very dense, owing to the prominence of New York City, the share of dense housing structures as a percentage of all units has fallen sharply since 2019.
In sum, greater housing—especially in urban areas—would provide reduce inflation and interest rates while lowering emissions. Expanding dense, urban housing options should be a top policy priority.
There are several ways to accelerate housing construction.
The most important step is to identify the problem and mobilize actors across all levels of government—national, state, and local—to build housing as quickly as possible.
Legalizing apartment units, including same-lot units, and eliminating parking requirements are also important steps for cities. Additionally, lowering or eliminating tariffs for some housing inputs, such as softwood lumber imports from Canada, would incentivize housing construction. Incredibly, the US Commerce Department is considering raising duties on Canadian lumber imports. This action would raise consumer prices and disincentivize new housing. It would constitute a profound error with grave inflationary and climate consequences. Instead of raising tariffs on what is arguably the United States’ closest ally, Washington should vigorously pursue policies that decrease shelter costs as quickly as possible.
Reducing shelter costs should be considered a primary priority for US policymakers. While apartment rental price increases have recently abated, and even begun to decline in some markets, these benefits have often yet to pass through to consumers on year-long leases. Rental prices may decline further if action is taken at all levels of government. If housing prices continue to lift inflation, however, the consequences could be profound.