More on Inflation and Housing Costs

Irwin Kellner of Marketwatch picks up on the question that I posed last week of how inflation in house prices affects official inflation data. He takes the reasoning that I suggested — that when house prices and rents diverge, the CPI may not give as good a picture of the cost-of-living as we would like (see these comments by David Altig and Mark Bryan for more on the subject) — a bit further:

HEMPSTEAD, N.Y. (MarketWatch) — The faster the increase in home prices, the slower the rise in the consumer price index.

That’s right, the CPI is being held down by the method that the Bureau of Labor Statistics uses to calculate the housing component of this key index.

…[I]n today’s topsy-turvy world… the faster home prices rise, the slower the increase in rents. In some locales, rents have actually declined.

The reason is not hard to fathom. With interest rates as low as they are, people would rather buy than rent. That’s why the percentage of households that own their homes has jumped from 64 percent 10 years ago to 69 percent today.

As the demand for owning goes up, the demand for renting goes down. This pushes prices for homes higher even as it holds down their rental equivalent.

Personally, I’m very skeptical that there’s actually a negative correlation between house prices and rents as Kellner suggests, in anything more than a few isolated instances in the past couple of years. But I do agree with him that when house prices and rents do happen to diverge (as they have in recent years) then that raises questions about the accuracy of the CPI as a measure of cost-of-living increases.