Sunday, April 24, 2011

you can't hit what you can't see

I am heading to Mungotown to talk about monetary policy. I was researching the question of whether the Fed should target asset bubbles (and by target I mean, prevent / deflate!!). Chairman Ben's point of view is that the Fed should do so only to the extent that the bubble bleeds into overall inflation.

At this point something burbled up in my reptile brain; "housing is about 1/3 of the CPI, how could it have soared so far without bringing inflation along?"

People you probably know this already, but in 1983, the BLS redefined how to measure housing costs to "owner equivalent rent", and this variable didn't much move with housing prices in the last decade.

Here's a graph, courtesy of Dr. Housing Bubble (clic the pic for a more glorious image):

The red line shows the growth rate in the Case-Shiller housing price index, the blue line shows the growth rate of housing component of the CPI.


From 1998 to 2006, there was a complete disconnect between housing prices (rising like crazy) and the BLS measure of owner equivalent rent (which never went up more that 4% in any of those years).

Hard for a bubble to bleed into inflation when it's been defined out of the index!


Frank said...

It's hard to do numbers without theory. In glaring hindsight, I suppose Case-Shiller moved with a bubble, investors renting out at a low price to defray their carrying costs until they cashed in the asset.

BLS used to say the CPI wasn't a Cost of Living Index, but that's all it has ever been. And that's still all it is.

Anonymous said...

The CPI does not include stock prices either. It is not intended to go up and down with the price of assets like land; it is intended to approximate the price of consumption (including services). Despite the bubble in land prices, home rents did not skyrocket. Homeowners were *not* giving up tons of cash by not renting out their (temporarily expensive) homes. (And it is not like the Fed was unaware of the housing bubble, just because it did not show up in the CPI.)
Interested readers are encouraged to check out the economic theory about measuring housing cost inflation; for example, see the work of Erwin Diewert. Steve Cecchetti started out as a critic of owners' equivalent rent, but changed his mind after studying the literature and thinking about it for a while.

Jesus M. said...

One of the candidates for an eco job here at Lehigh presented a paper on the relationship between housing values and non-housing expenditures. Apparently, there's a big literature about this. It was interesting. I forget the conclusions ha!