Housing and CPI Calculations

From a quick google search for information on rent equivalent housing calculations, I came across this from Greg Nyquist.

When calculating the CPI numbers for houses, the Bureau of Labor asks a selected of sample of home owners: "If someone were to rent your home today, how much to you think it would rent for monthly, unfurnished and without utilities?" In other words, the CPI-related figures of the housing market are based, not on actual housing prices, but on asking homeowners to speculate about the rental value of their property. In other words, it's not based on anything real! Not surprising, these speculations tend to provide lower CPI figures, since rent values, upon which these speculations are based, tend to trail housing prices, especially following dramatic housing price spikes.

But there is another mechanism by which CPI will be understated even if sharp spikes are not involved.

Consumer goods can be separated into two general categories, present goods and future goods. When a consumer good is up for purchase consideration, the subjective marginal utility of the satisfaction that it is expected to provide is compared with the marginal utility of the cash required for its purchase. In this process future satisfactions need to be discounted back to a present value at some discount rate.

It should be clear that a month's rent is the payment for a present good, while the payment for a house is largely buying future satisfactions.

This is why a house will see its market value increase greatly if interest rates are lowered and rental rates will remain relatively constant, being primarily dependent on demand rather than yield on current market value.

In summary, when the FED expands credit and suppresses interest rates, using even real market rental rates as an equivalent for housing prices would greatly understate the resulting price inflation and CPI.

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The issue, of course, is a

The issue, of course, is a practical one. How does one measure the market value of a particular house from month to month (or probably more realistically, year to year)? The best one could do is with a regular appraisal of the property value. Remember, price indexes are calculated under the assumption of a fixed market basket of goods over a specified period of time.

That said, I wonder if the average price per square foot within particular neighborhood (specifically, a precisely defined geographic area) act as a good proxy? One would assume that things like number of bedrooms, new heating systems, finished basements, quality of schools, etc would be already be accounted for in the price. Here, the "item" in the market basket is not a particular house, but a square foot of residential property.

I *could* just walk down the hall and ask those cats in the CPI what's the story, man....

Missy, Thanks for your

Missy,

Thanks for your salient comment.

Of course, from the Austrian viewpoint, all indices are problematical. The likely reality is that it is appropriate to not think of the CPI as an attempt at an accurate measurement of something that cannot be measured, but rather as a political tool employed to facilitate the political imperative to inflate that is ingrained in every central bank.

Regards, Don

This analysis of a problem

This analysis of a problem with CPI measurement, and there are many others, exemplifies why, as Mises I believe said, the use of a basket-of-goods approach to measure "bad" inflation is fallacious. The very concept is flawed. That is why the only proper approach, arguably, is Mises's a priori approach: a government-induced expansion of the supply of money (bill-printing, credit expansion) is by its nature bad because of the distortions that necessarily will follow, logically and necessarily. You cannot exactly measure those distortions, as they will be different in every market and you get into Heisenberg issues. You cannot logically dispute, however, the distortion. Hence, Austrians say inflation properly defined is inflation of the money supply, not the consequence of "artificial" price increases (or resistance to natural price decreases).

Nonetheless, it doesn't hurt to point out the fallacies of the CPI when they show themselves so clearly.

mike, For more on what you

mike,
For more on what you wrote, see this post, also written by Don, by right-clicking and using "Open in New Window".