The July 12, 2023, WSJ article, " Measure It Differently, And Inflation Is Behind Us," triggered a lively debate on housing costs in the CPI. The WSJ article argues that "no one pays" the rent used to measure owners' housing costs, so it should be overlooked or ignored. No one liked the results when BLS included "actual" housing costs based on prices, so government statisticians, academics, and politicians collaborated to change it.
So what is best, a CPI with no price for housing costs, a "fake" price, or an "actual" price? The answer is more than academic, as it will have significant implications for monetary policy and how the business cycle runs and ends.
The main opposition to including the price of a house in the CPI stems from the view that housing is an investment item, disqualifying it from inclusion in the consumer price index. Yet, the CPI has other investment items (e.g., watches, jewelry, etc. ). But since the weight of those items is small, their inclusion is not controversial. So is the housing issue, the investment angle, or the weight in the index? It appears to be the latter, as "consistency" in measurement takes a back seat.
Critics also argue that people borrow money to purchase a house. So if the cost of a home, including financing costs, increases every time the Fed raises rates, housing inflation would rise, forcing the Fed to raise rates again and again. People borrow money and finance (credit cards, auto loans, etc. ) every good and service in the CPI, and these financing charges have significantly increased since the Fed raised the official rate. So why should housing financing be treated differently?
A consumer price index, including house prices, does not necessarily mean a higher consumer price index. The consumer price index will yield the same result if house price increases match other items' average growth. Only if house price increases were significant and persistent would there be an impact on the CPI.
The CPI, the government now publishes, has increasingly been enmeshed in the politics of the numbers. Printing a lower CPI than a higher one is more politically acceptable, even if that means including "fake" or "inaccurate" prices over actual prices.
With house prices living outside the standard price index nowadays, it is impossible to ascertain the aggregate actual inflation rate in the economy. That makes the Fed's job on price stability more complicated. That's because setting rates for a price index without housing risks the real cost of credit too low for real estate. Fifty years ago, Professors Alchian and Klein authored a paper, "On a Correct Measure of Inflation, stating " a price index used to measure inflation must include asset prices." Their analysis and conclusion are still valid today.
Comments