Why the Fed Chases Its Tail: Rent Measures vs. Case Shiller

Mish

The Rent Café gave me their weighted national rental price data. Let's compare to the CPI and Case-Shiller home prices.

Rent Café vs Owners' Equivalent Rent vs Rent of Primary Residence

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Data courtesy of the RENTCafé and the BLS Owners' Equivalent (OER) via Fred the St Louis Fed repository.

The Owners’ Equivalent Rent (OER) Calculation method is absurd.

The expenditure weight in the CPI market basket for Owners’ equivalent rent of primary residence (OER) is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence:
“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

OER is the largest single component in the CPI. It makes up 24.28% of the index. The CPI category, rent of primary residence is 7.8% of the CPI.

January 2018 Year-Over-Year Comparison

OER Substitutes

  • CPI-U Using Rent Café: 1.97%
  • CPI-U Using Primary Rent: 2.19%
  • CPI-U Using Case-Shiller: 2.85%

The direct cost of purchasing a house is not in the CPI because the BLS considers housing as “capital goods”.

Tail Chasing Exercise

Whether or not one agrees with the BLS treatment, the Fed made a huge mistake ignoring escalating home prices in the housing bubble years.

And they are doing it again now. Another round of asset bubble deflation is coming up.

The Fed chases its tail in a perpetual cycle looking for inflation, not noticing the obvious, measurable price inflation in home prices and other assets.

Mike "Mish" Shedlock

Comments (15)
No. 1-15
hmk
hmk

I still think its deliberate most likely due to political pressure. If inflation numbers are reported below the true rate who benefits most? The govt, theycan keep interest rates low so they can continue their unchecked largess with minimal financing costs. If they paid a real marketplace determined rate of interest there would be economic chaos.

bradw2k
bradw2k

2nd mortgage defaults have been rising sharply for a few months: https://us.spindices.com/indices/specialty/sp-experian-second-mortgage-default-index

Roger_Ramjet
Roger_Ramjet

I have never been contacted by government pollsters to inquire about the OER on the house I have owned for 17 years, but if they had at any time, I wouldn't have had a clue. My gut tells me I would have been way off.

Carl_R
Carl_R

The GDP Deflator is a much better measure of inflation, and avoids all these kinds of problems entirely.

Runner Dan
Runner Dan

The Fed's blindness to the housing bubble is intentional, as the inflated house prices helps make their insolvent banking system appear to be not so insolvent. The government doesn't mind helping out with the inflation process since they derive taxes from it. Higher house prices means more tax revenue and so these days the government is directly/indirectly involved with, I believe I read somewhere, 80% of all home purchases. Of course, this all is disguised as "helping people achieve the American dream". Really, this is just one of the three major fronts of the generational war whereby the older generation attempts to extract wealth from the younger. The other two fronts are higher education and healthcare.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

The GDP deflator does not factor in home prices

Carl_R
Carl_R

The problem with a CPI style measure of inflation is that you have to agree on a market basket, which brings up thorny questions of the appropriateness of substitutions, owner equivalent rent versus home prices, etc which people can argue about ad naseum. The deflator simply looks at the basket of all goods and services produced in a year. While a home itself is not a good or service, things that are included into a home, such as lumber, nails, glue, fixtures, appliances, carpets, etc would be goods. In actual practice, the CPI and GDP deflator are very close, so all the nit picking about what should or shouldn't be included in the CPI strikes me as spurious. If the CPI was lower than the GDP deflator, and especially if it was significantly lower, then I would take arguments that the CPI is too low seriously, but instead the deflator confirms that the CPI is not significantly wrong.

RonJ
RonJ

Of coarse, one size doesn't fit all. Rent and home prices have gone sky high in the San Francisco Bay area. Trump is doubling down on the deficit and Chinese banks just pumped $458 billion worth of new loans in January, some 5 times that in December. An uber dove is supposedly signing on at the BOJ. Print, print, print.

Stuki
Stuki

“While a home itself is not a good or service, things that are included into a home, such as lumber, nails, glue, fixtures, appliances, carpets, etc would be goods.”

If the cost of a house in Pacific Heights could be determined by adding up its lumber, carpet and fixture prices, America wouldn’t be in the shambles it is in in the first place. And neither would what currently passes for “economics” necessarily be nothing more than a tragic joke.

The fundamental silliness is attempting to classify some things as part of inflation, some not. Not the specific details of how the that classification is broken down. In the real world, there is no God given delineation. Nor a delineation with economic relevance, at a population wide level. Heck, in the real world, there are no fixed classifications at all. Those only show up as part of the progressive canon, on account of progressives needing the world simplified to where they can pretend to understand it, by counting: One. Two. Many. instead of bothering to figure out how to get all fancy and stuff, and use their fingers.

Bubble gum and government bonds are not magically “different.” You can, in fact, walk down the street chewing on either one. Or, you can hold them to maturity. At which point, given current spending and debt trajectories, it’s anybody’s guess which one still retains the most value.

Carl_R
Carl_R

"The fundamental silliness is attempting to classify some things as part of inflation, some not." And that is the flaw of the CPI. By working from a market basket, they have to begin by defining exactly what is or isn't part of inflation. If it's not in the basket, it doesn't count. If it is in the basket, but you personally don't buy it, it doesn't matter, because it does count. The faster they do substitutions, the closer it gets to what our real spending patterns are, but then people object to that, too, because the substitutions don't fit their specific spending pattern. For example, if 90% of the country switched to electric cars, the 10% who still ran gas engines would complain if the CPI market basket added more electricity, and decreased the petroleum component (even though that substitution would be entirely appropriate).
Since the GDP deflator doesn't work from a market basket, but rather from the entire GDP, it doesn't reflect any specific market basket, but rather what the entire economy purchased. The deflator doesn't ever attempt to define what is or isn't part of inflation; instead, each person that purchases a good or service defines what is or isn't part of inflation.

Stuki
Stuki

“The deflator doesn't ever attempt to define what is or isn't part of inflation; instead, each person that purchases a good or service defines what is or isn't part of inflation.”

Including stocks, bonds and land titles, I presume……..

Probably not entirely fair, as those aren’t counted as part of GDP either, and the deflator was never intended to be relevant outside of the context of GDP. But that just gets to the crux of the problem: GDP itself. Or, more to the point, the unwarranted significance attributed to GDP as some sort of final measure of the health of “the economy.” GDP itself may be a useful measure for some things. (Although I’d be hard pressed to come up with exactly what, in an age of ever increasing activity being performed simply to not slip too far back on the treadmill of ever increasing roadblocks, mandates, taxes, pillage by ambulance chasers and others, and regulations. All of whom decrease utility without a similarly negative effect on GDP. As an aside, the result that “activity” is a valid approximation of economic health, is justifiable in a completely free world, where no choice is coerced, no act mandated nor encouraged above others, no action barred nor discouraged etc. Pretending the same holds true in of world of officially set prices; 5 year plans dictating production and mandating consumption; rules, regulations, taxes; as well as all outcomes being dictated by government policy rather than unconstrained market mechanisms; is just intellectually dishonest hand waving, obfuscation and sleight-of-hand.)

But I digress. Back to the deflator: Since GDP doesn’t include changes in the value of “assets,” neither does the deflator. Yet an increasing share of people’s de facto income (as in delta wealth + spending over a period), derive from just such asset price increases. While a similarly increasing share of people’s expenditures and economic activity, is directed towards buying, selling and researching things classed as assets. With the result that the supposedly “all inclusive” GDP deflator, not only is much less than all-inclusive; but is, in fact, becoming less and less all-inclusive over time; as a realistic measure of the change in prices for what people actually spend their money on.

nic9075
nic9075

Rents have been skyrocketing for most of the 2010's. As I have observed, rent in the $2,000's now per month is the new 'normal' in most cities. In Manhattan (and most of broooklyn $3500 - $5000 is the 'new normal (for a small unspectacular one bedroom apartment.. Once thing seems certain, an apartment that rents for three figures a month has gone the way of the 10 cent parking meter in Manhattan

nic9075
nic9075

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nic9075
nic9075

Of coarse, one size doesn't fit all. Rent and home prices have gone sky high in the San Francisco Bay area. --- Uh they have been 'sky high' in the bay area for the past 5 years nothing new there. Check out rents in Manhattan and in the greater Boston area (which are much higher)


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