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Swedens central bank recently lowered their prime rate to -0.25% from -0.10% in an effort to avoid deflation.

At the same time, house and apartment prices are higher than ever, up 11% last 12 months, and up hundreds of percents the last 5-10 years. Measures are taken to avoid a housing bubble, like regulations on mortgage payments and so on, these are having an effect but the effects of a rapid rise in rate would be disastrous.

As I've understood, and I guess this might differ from country to country, the measure of inflation, CPI, includes prices for services and goods, but not for houses and apartments, why is that? In Sweden, rent for apartments and the bank rate are included in CPI, but the consumer isn't paying rate, they pay rate * house prices.

If house prices were included in CPI, we would definitely have inflation rather than deflation, so the right action would be to increase the prime rate, which would also lower house prices.

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Because including that in CPI would in a sense make the measure intertemporal, which would make it hard to compare relative CPI levels. I think. –  mathtastic Mar 25 at 2:55

2 Answers 2

The CPI stands for a Consumer Price Index. As in the price of things that are consumed (at a particular moment in time). Real estate prices are not the price of something consumed because they contain the value of current housing consumption but also the capitalized value of future housing consumption. As such, including house prices would make the CPI a mixture of consumption at different times, and therefore unsuitable for comparing the price of consumption bundles at distinct times. Instead, they use a purer measure of the price of housing consumption: rents.

Rents reflect the price of consuming a flow of real estate services at a moment in time. Of course, many homes are owned by the occupants and not rented. Therefore, the calculators of national accounts generate something called "owner occupied rents", which is an attempt to calculate what the rents would be on homes that are occupied by their owners. This measure has problems, but for many purposes is quite adequate (Crone, Nakamura, Voith (2004)).

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An additional reason why house prices are not included in the inflation measure is that some housing contracts are indexed by inflation. I seem to remember that this was/is the case for the UK [citation needed]. If then you include housing prices in your inflation measure, you get loops/amplification of nominal inflation:

  • Renting contracts indexed with inflation
  • Hence nominal value of houses increase with inflation
  • Inflation measure also increases with housing prices

Indexing (e.g. renting) contracts by inflation is called an escalation agreement: If, say, inflation increased a lot, a fixed renting fee would harm the property owner a lot, hence parties often agree on an Escalation Agreement.

I also believe but I could be wrong that this subject was partially touched in this EconTalk episode.

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This doesn't really make sense— an increase in mortgage payments/loan balance doesn't necessarily translate to an increase in the value of a home, and as BKay accurately described above, the only part of housing that matters for CPI isn't the price of the housing asset (because asset price inflation is explicitly excluded from a measure of consumer prices), but the price of the housing services (i.e., rent). –  dismalscience Mar 19 at 14:47
@dismalscience I tried to clean it up. Bkay's argument is only "it is hard to disentangle current from future consumption in a value of housing", hence we don't do it for housing, but only for rental. In the "best world", we would still include housing consumption as a part of the CPI, because it is consumption - it is just hard to do. I bring forward an argument why even in this best world, if we could disentangle current from future housing consumption, there is a reason why we wouldn't include it in the CPI. –  FooBar Mar 19 at 14:55

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