South-Western College Publishing - Economics  
Measuring Housing Prices
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words

Inflation, Housing Prices

News Story

The National Association of Realtors are projecting that the median sales price of an existing home will increase in 2005 by 8.8 percent. This prediction follows an actual increase in housing prices of 8.3 percent in 2004. Yet, the Bureau of Labor Statistics, the government agency that collects data and computes the Consumer Price Index, says that housing costs rose by just 0.1 percent in May, and by only 3 percent in the last 12 months.

Since housing is the largest single expenditure for most American households, the statistics give cause for question. Why is the rapidly increasing price of housing not being reflected in the CPI? The answer lies in the way the government collects and uses the data it collects related to housing.

Until 1983, the BLS measured housing inflation by collecting data on what it cost to buy and own homes, considering factors like house prices, mortgage interest costs, and property taxes. The problem was, that these data could show big bounces from month to month, producing an erratic measure of housing inflation. Since homes are somewhat of a hybrid of a consumable good and an investment good, the bureau wanted to "separate out the investment component from the consumption component" of the housing market, said Patrick C. Jackman, an economist at the BLS.

The BLS decided to track a measure that represents only the consumption of housing, and the measuring stick they use is rent. Rents have much to recommend themselves as a long-term measure of inflation. Rents don't rise and fall significantly form month to month, and they are considered a good proxy for housing prices because over time they correlate very closely to home prices.

"It's important to separate the decision that people make about housing as an investment and housing as a consumption of services," said Ted Wieseman, an economist at Morgan Stanley. The bureau is trying to measure consumer price inflation, not asset price inflation.

So, for the past 22 years the BLS has measured housing inflation in an indirect way. The bureau collects information from thousands of Americans about how much they pay for rent. Then they ask homeowners how much they would have to pay to rent the house in which they live. This data, part of the bureau's Consumer Expenditure Survey, is then statistically converted to part of the Consumer Price Index. The housing component is by far the largest, constituting about 23.2 percent of the CPI. The next largest is transportation at 17.4 percent, and then food at 14.3 percent.

So even though the hot housing market is causing home buyers to spend more of their income for the same amount of housing, the comparatively soft rental market is holding down inflation as measured by the Consumer Price Index.

Questions
1.

Do you think rent is a good proxy for home prices?

2. Do you feel housing is more of an investment good or a consumption good?
3. Use any source available to find out how residential construction is include in GDP. (Hint: Is it included in investment spending or consumer spending?)
Source Daniel Gross, "How Home Prices Can Be Hot but Inflation Cool," The New York Times Online, June 26, 2005.

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