Owner Occupied Housing in the CPI and Its Impact on Monetary Policy During Housing Booms and Busts

Abstract

The treatment of owner-occupied housing (OOH) is probably the most important unresolved issue in inflation measurement. How -and whether -it is included in the Consumer Price Index (CPI) affects inflation expectations, the measured level of real interest rates, and the behavior of governments, central banks and market participants. We show that none of the existing treatments of OOH are fit for purpose. Hence we propose a new simplified user cost method with better properties. Using a micro-level dataset, we then compare the empirical behavior of eight different treatments of OOH. Our preferred user cost approach pushes up the CPI during housing booms (by 2 percentage points or more). Our findings relate to the following important debates in macroeconomics: the behavior of the Phillips curve in the US during the global financial crisis, and the response of monetary policy to housing booms, secular stagnation, and globalization. (JEL. C31; C43; E01; E31; E52; R31)

Measuring the Services of Durables and Owner Occupied Housing

“…121 See Heston and Nakamura (2011). Hill, Steurer and Waltl (2017;8) find similar results for Australia and Aten (2018) finds similar results for the US. Shimizu, Diewert, Nishimura and Watanabe (2012) found that user cost valuations for OOH in Tokyo were about 1.7 times as big as the equivalent rent estimates.…”

“…147 We note that the above adjustments for the timing of payments have implications for the system of national accounts that have not been fully worked out. 148 Hill, Steurer and Waltl (2017), using Australian data, found substantial differences using the three main approaches to the valuation of OOH. This emphasizes the need for statistical agencies to produce estimates for all three approaches if possible.…”

“…Eurostat (2005) also uses a simplified user cost formula. Additional simplified user cost formulae have been developed by Hill, Steurer and Waltl (2017) and many others. 31 Since landlords must set their rent at the beginning of the period (and in fact, they usually set their rent for an extended period of time), if the user cost approach is used to model the economic determinants of market rental rates, then the asset inflation rate i 0 should be interpreted as an expected inflation rate rather than an after the fact actual inflation rate.…”

“…The Australian Bureau of Statistics has used this method for determining r t with r *  0.04; i.e., a 4 percent real interest rate was chosen. Other methods for determining the appropriate interest rate that should be inserted into user cost formula are discussed by Harper, Berndt and Wood (1989), Schreyer (2001) and Hill, Steurer and Waltl (2017). 36 We will discuss geometric or declining balance depreciation and one hoss shay depreciation below.…”

“…Diewert and Fox then replaced the ex post capital gains term in the user cost for land with the long term inflation rate for land over the previous rolling window of 25 years and this substitution led to positive user costs for land that were relatively smooth. Hill, Steurer and Waltl (2017) also recommend the use of long run asset inflation rates to avoid chain drift in housing indexes based on user costs. 39 For example, property taxes are associated with the use of housing services and hence should be included in the user cost formula; see section 16 below.…”