Fun With Government Statistics

After yesterday's long, serious post about the end of economic growth in the 21st century, I thought we should explore the lighter side of things today. The New York Times' Floyd Norris explains why the government does not include house prices in calculating the inflation rate.

Until 1983, the Consumer Price Index (CPI) included housing costs. But then the index was changed. No longer would home prices directly affect the index. Instead, the Bureau of Labor Statistics makes a calculation of “owners’ equivalent rent,” which is based on the trend of costs to rent a home, not to buy one. The current approach, the B.L.S. says, “measures the value of shelter to owner-occupants as the amount they forgo by not renting out their homes.” The CPI is not supposed to include investments, and owning a house has aspects of both investment and consumption.

If house prices were included directly in the CPI, we would "officially" be experiencing massive deflation in "core" CPI (excluding food & energy). But using owner's equivalent rent (OER) yields a far different outcome.

Graph from Tim Iacono's How Owner's Equivalent Rent Duped The Fed

You can easily see that house prices are looking for the bottom again, but OER is skyrocketing. Needless ot say, this gives a somewhat misleading picture of what is really happening to prices. We might even go so far as to say that the "official" inflation rate which heavily influences the interest rate policy of the Federal Reserve is complete nonsense. Read both the Norris and the Iacono articles if you want the grisly details.

As a recent zerohedge article Benefit To US Economy From Deadbeat Squatters: $50 Billion Per Year points out, the disparity between OER and actual house prices introduces a number of distortions into government statistics.

Rental income has been soaring. In yesterday’s February personal income report, rental income of persons increased 2.6% on the month to $326 billion. After bottoming at $120 billion in February of 2007, rental income has nearly tripled in the subsequent four years. Even though rental income accounts for less than 3% of personal income, over the past four years it has accounted for over 16% of personal income growth.

This rise has little to do with landlords getting more from their tenants. In fact, it has very little to do with what speakers of the English language would normally consider "rent." Instead, [the rise] mostly reflects mortgage payments of the household sector coming down, in part because of the aggregate decline in household mortgage debt due to net cancellation of mortgages associated with foreclosures.

I know how you must feel at this point. I feel exactly the same way. It is simply shocking to find out that government statistics are giving us a misleading picture of how the economy is faring. But that is not their real purpose, as we shall see.

Mr. Juggles at Long Or Short Capital has figured out how to straighten out this mess. His brilliant idea is to use a new inflation measurement, as he lays out in his post Announcing the CPI-F (flat).

The WSJ’s Heard on the Street column is generally pretty good. So the title of a recent entry, “Housing Bubble Continues to Haunt Fed“, made me interested to hear adults talk about the current stagnancy in real estate and how the hangover from the bubble still lingers. But I didn’t hear any of that malarkey.

Instead, I learned that people are debating whether housing plays too big a role in the CPI; specifically, the “problem” is that the housing portion of the CPI is exerting upward pressure on the overall number. Y’know because consumers typically live somewhere and pay for that privilege.
“OER [editor's note: "owners' equivalent rent"] is expected to jump to 1.2% year-on-year in December from 0.6% in February, despite a sluggish housing market.”
1.2%!! This is getting serious.

So what should we do?
“Some suggest alternative inflation measures.”
Oh ok. Well, what are “some” proposing?
“A ‘supercore’ alternative excludes not just food and energy but shelter, too, to gauge underlying trends.
There is great opportunity for the Government to reduce CPI by excluding more items.

And with that admirable goal in mind, Mr. Juggles proposes the CPI-F (flat).

This new CPI, CPI-F (flat), will provide data on all changes in the prices paid by urban consumers for a representative basket of goods and services whose prices demonstrated a slight and consistent level of inflation.

We expect it to have the most consistent and consistently low inflation readings of all the CPI measures. Its current reading is 1.5%. In the future, the monthly CPI-F level will be reported on the 5th of the following month, unless there is no change to the index, in which case you can continue to use the prior month’s reading.

Here is a pro forma chart that demonstrates what inflation would look like as measured by CPI-F since 1900.

Hats off, Mr Juggles! This is just the kind of innovative thinking needed to improve government reporting of inflation. If the goal of government statistics is to make us all feel good about how things are going, and that appears to be the case, the CPI-F is bound to have the intended effect