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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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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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    $\begingroup$ "because they contain the value of current housing consumption but also the capitalized value of future housing consumption" could you explain what this means please? $\endgroup$ – Vinayak Pathak Dec 14 '15 at 3:15
  • $\begingroup$ @VinayakPathak: It's just a way of saying a house is both a real asset and an expense simultaneously. The house's market value could appear on your personal balance sheet. But the month's rent expense would be a cost-of-living item that would flow to your income statement. The former is not useful for measuring a price index. While the latter is. $\endgroup$ – Mowzer Jul 27 '16 at 6:42
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Rents are included in the CPI, because they are expenditures that are "consumed" in current period of time.

But house prices are not, because they are expenditures on an asset to be consumed over many years. If you own a house, you will benefit from the rising prices--if and when you sell it. In a sense, houses are treated like capital goods--for consumers. That is, rising house prices are not a burden to home owners, whereas rising rents are a burden to renters.

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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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    $\begingroup$ 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). $\endgroup$ – dismalscience Mar 19 '15 at 14:47
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    $\begingroup$ @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. $\endgroup$ – FooBar Mar 19 '15 at 14:55
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Experts argue that "raw" (i.e. the cost of actually purchasing a home) should never be included in CPI's because homes are not viewed as something people buy on a regular basis.

But that argument really becomes unstuck when you factor that reserve banks around the world use (WRONGLY in my opinion) CPI to determine interest rates.

The largest purchase for many people across the globe that relate directly to interest rates, is not shares, businesses, cars or any other similar investments, but homes. So it affects the prices of homes and their affordability directly through the setting of interest rates (remembering people need to borrow to buy a home in 99% of cases) and yet these same institutions and their simple minded economists refuse to take into account the growth of the same home prices when determining interest rates.

Inflation in real terms should be a measure of everything purchased in the economy whether it be a home, investment or bread.

Otherwise you have ridiculous situations globally as we have now where the indicators most economists use blindly are saying we have negative inflation, so interest rates are dropped and house borrowing and house prices go through the roof. If a housing market goes up 20% per year in some countries then should this not be included in the inflation rate? Because if house prices were included interest rates would be on the way up and not down.

We are currently being told by the "other" experts without vested interest in banking or housing sectors that the biggest problem in todays global economy is low interest rates fuelling asset bubbles (the biggest being residential housing in many countries). One way to fix this problem and easily is to start including house prices into CPI's and not burying our heads in the sand with ridiculous arguments as why not too. Yeh sure those in recent times who borrowed to much in a bubble asset class will take a massive hit. But it is a massive hit for the few that needs to happen for the better of the many in the medium to long term.

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    $\begingroup$ This reads much more like a rant than an actual factual answer, doesn't it? $\endgroup$ – clem steredenn Jul 27 '16 at 7:08
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That's a good question. From my understanding in economics classes I have taken here in the U.S., home prices are not included because they are too volatile. The same goes for energy / oil prices. Home prices are very dependent on interest rates and their supply is relatively inelastic (because you can't quickly manufacture 10,000 new homes in a city when demand increases). This causes volatility. Hope that helps!

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I think house prices are not included in the CPI because in would harm one of the main drivers of the economy: real estate. Banking, law, insurance, construction, renovation, landscaping, engineers, appraisers, realtors, home decorators, civil servants, etc. The list is truly astounding, and this is not even accounting for the indirect impact of all these wages being spent to support other segments of the economy.

We live in a real estate economy.

If they were to increase interest rate to curtail inflation of house prices, they would kill the growth rate of the whole economy in a heart beat. Furthermore, low interest rates are highly destructive for pension funds, which adds onto the pressure of keeping the real estate going: this asset class is becoming the new retirement plan for many people (can't wait to see the impact of population aging on that: a real time bomb).

Lastly, the majority of the wealthiest people in a typical town or city made (or grew) their fortune through real estate investing. These people are also heavily involved with town/city politics as real estate investing is highly dependent on regulations (zoning, development planning, transit planning, etc.). Local politics constitute the backbone of regional and national politics. Interestingly, the typical government "stimulus" spending addresses local infrastructure needs that are also crucial for real estate performance.

I apologize for not bringing a whole lot of math here, but economy is a soft science; not including the house price in the CPI makes no mathematical sense to me anyway.

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  • $\begingroup$ Seems like what you describe is a bubble, not growth. $\endgroup$ – Giskard Oct 4 '16 at 14:56
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House Prices were removed from inflationary measures in order to allow for personal debt to be driven upwards. The monies borrowed by people 'appearing' within the economy without triggering any inflationary triggers allowed (essentially) for people to save less and borrow more whilst continuing to drive down borrowing costs. In the UK Gordon Browns miracle economy was only personal debt. Just that. Smoke and Mirrors.

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  • $\begingroup$ To me it seems rather far fetched that the government would manipulate the statistics in order to increase borrowing. If they wanted to do that they have more efficient ways of doing that. Also, statistics offices are supposed to be independent of the government. Do you have any evidence of this claim? $\endgroup$ – Maarten Punt Feb 15 '18 at 15:36
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Factual answers? Economics is both art and science so there is no universal answer to what should/should't be included in the CPI calculation or the Feds decisions as a result. I have the same concern about the impact of housing on CPI. In this case I agree that it should be a primary driver of the CPI and the Feds decision. When housing costs are considered, it is incorrectly aggregated (rents etc) to paint a mediocre and inaccurate picture of the overall cost of housing. I completely understand all that is written above but nearly ignoring the largest dependent cost variable to rates is only ridiculously convenient.

The fact is that housing is the largest purchase for every American consuming household and as the cost of the debt to purchase homes decreases the cost of the housing increases. All other family expenditures are adjusted to accommodate housing. The fact is: 1) housing prices have increased astronomically because of one primary reason (historically low interest rates) which then have second and third order affects further causing other bubbles in the metro housing markets. Some of those are that state and local municipalities, needing more and more tax base, and unable to continuously increase income taxes, encourage over-building large homes (too big for young families) because those garner the most tax revenue. It is exacerbated by the fact that jobs and intellectual resources are moving from rural areas to major cities where affordable single family housing is in very short supply, which goes unrecognized when considering the CPI and rates. Averaging the cost of housing in rural Indiana (decreasing demand) and Indianapolis (increasing demand) isn't useful information. A more accurate picture of housing costs is to look closely at only single family home prices (not rents..condos.. (very few people want to live in one with kids) and where btw HOAs or other fees aren't included) in major metro areas in each region. 2) With low rates, the costs of college education has been driven up and the risk appetite at Universities to compete, results in high levels of in student loan debt, making it difficult for the college educated to buy a house later on. So the art of the Feds decision in considering CPI should include weighing single family housing prices in metro areas more heavily. A

lso, it should be pointed out that as long as rates are low, the issue of 'income inequality' will be a problem. Seniors and lower income groups rely heavily upon decent bank savings rates to save for the future. Lacking that rate incentive, those groups are less likely to save and later invest to buy a home or move. At some point, the rate of housing price inflation must slow or deflate. Wages aren't increasing and the combination of government debt and private debt will put tremendous pressure on the consumer economy unless we slow this madness by considering the real consumer prices by raising rates gradually.

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