Thursday, June 21, 2012

Mismeasuring Housing Distorts Inflation Data

One major pet peeve of mine, regarding economic data, is the manner by which inflation is calculated and the certainty often prescribed to that calculation. A notable criticism stems from the recent bubble and bust in housing. As Evan Soltas notes:
With the exception of the GDP deflator, the CPI and the PCE all use a measure of housing prices called "owners' equivalent rent," or OER. What OER basically entails is the Bureau of Labor Statistics (BLS) asks homeowners for their own assessment as to the potential rental price of their own home -- and as a result, what OER has failed to count has been the asset-price inflation of housing.
To provide a more clear depiction of this failure, here is a chart comparing the CPI-OER and a broad measure of housing prices (S&P Case-Shiller 20-City Home Price Index) since 2000:

As seen above, housing prices have been extremely volatile during this period compared with the measure of OER. Equally noteworthy, the OER has continued to rise over the past several years even as nationwide housing prices have cratered. Given the influence this data has on monetary and fiscal policy, ensuring the accuracy of its relevance to prices faced by households is critical.

Evan continues:
I bring this up, in part, because there's been movement by the Office for National Statistics in the UK to replace their CPI and RPI, or Retail Prices Index, with a CPIH, which would include some OER and some mortgage payment costs. (The mortgage payment component is a proxy for asset prices.) At the same time, Eurostat, which compiles the HICP inflation numbers for the Eurozone, is considering a new approach to owner-occupied housing.
Both the Bank of England and the European Central Bank have figured out that they are mis-measuring housing; it's time for the Fed and the Bureau of Labor Statistics to introduce a CPI-H.

(Note: Evan’s post links to a couple CPI-Housing adjusted graphs he created on FRED that may prove useful. Check out his post for the links!)

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