CPI and housing prices

Posted by: Amey Stone on August 16, 2005

Wondering why inflation figures are so tame when real estate prices are soaring? There is a simple explanation: the Consumer Price Index factors in rising rents, not rising home prices.

The CPI for July was released today and rose 0.5% — just 0.1% (for the third month in a row) when you factor out energy and food prices. But 40% of the core inflation index is tied to rents. The “owners equivalent rent” index (derived from how much homeowners say they could charge in rent), rose by just 0.2%. (There was also a 0.9% drop in apparel prices, a 1% drop in new car prices).

“There are powerful forces holding the inflation rate down going forward, most importantly the weakness in the rental housing market,” commented Dean Baker, co-director of the Center for Economic and Policy Research in Washington, in a research note today.

It’s good for the economy and the stock market that inflation remains low. But are we really getting a true reading on inflation when home price appreciation isn’t added into the mix? I think not.

Reader Comments

Wes

August 17, 2005 4:17 PM

Of course we are not getting a true reading of inflation without house prices. Tell me any sectors that have had double digit pay inceases since 2000? I don't know of ONE.

I know that my pay has risen (from 2001-2005)- 5%, 3%, 3%, 5%, 3% yet in this time the local housing prices have risen 9%, 10%, 12%, 15%, 14%(YTD) respectively. (I'm lucky as well that I got a raise every year. I have friends who got nothing or took pay cuts).

This would work out assuming that houses were quite undervalued and have caught up with wage gains, but this is not the case and they were fairly valued and now house appreciation has outstipped wage gains.

Somewhere the math doesn't work out.

No wonder the rents are so low. With people buying housing there are less and less people living in apts. My rent has actually declined in proportion to my income, yet I am living in a ritzy area. As a dollar amount, I am still paying less rent this month than I did the same month 5 years ago. Everytime the complexes around here try to raise rents, people stop renting and the prices drop back down or they front-load contracts so over the 12-month life of it the acutal rent is similar to that paid 5 years ago.

If you're wondering why I'm bearish on housing, I think my explanation above serves its purpose. Rental prices have been static for 5 years while housing is up 73%. Some kind of fundamental is out of whack in Florida.

Mark

August 23, 2005 7:05 AM

Homes are an investment not a consumer good. In addition, when you take out a mortgage, you essentially pay yourself rent. While I agree home prices are inflated, it should not be used as a measure of inflation. Will the inflation index count all the increased value in peoples homes? Will it count the investments made into refurbishing people's home and the values before and after. Of course not! More people own homes than those for sale. Unfortunatly, many people have also refinanced at lower rates and spent the money. However, by cutting the cost of your mortgages it creates value and captures savings. When you add in all these positives less the increase in homes for sale on the market, the real rate of home inflation as it would some how relate to the CPI is nil.

Rob

August 25, 2005 5:27 PM

amey, good article.

the government will seek to maintain the housing market boom and keep the CPI data under control. right now rental housing is starting to pick up a bit (vacancies decreasing slightly from 10.4% to 9.8% in the last 18 mos.) while rents are increasing. meanwhile home ownership rates have fallen from 69.2% to 68.6%. as home purchase demand slows (prices level off and maybe even fall some) rents will rise causing a rise in the CPI. the fed will then have it's own conundrum on whether it can continue to raise interest rates as the CPI continues to increase due to rental housing costs and not just oil. but my guess is then the government will say that they have a new, better way to measure housing for the CPI and start using sales prices instead of rent since nearly 70% of americans own their own. then, as rents rise, and sale prices stagnate, the CPI can stay nice and low.

Mike

October 17, 2008 10:40 PM

Well, well, well . . . its now 2008 and we have the global financial crisis with cause rooted in a flood of cheap money caused by a Federal monetary policy that was looser than a French whore on Bastille day. This was allowed to happen - even welcomed - because inflation was "in check" as primarily indicated by the CPI.

I agree - and it certainly should be obvious now - that CPI should include housing (and energy.)

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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