"Until 1983, the bureau measured housing inflation by looking at what it cost to buy and own homes, considering factors like house prices, mortgage interest costs and property taxes. But given the shifts in interest rates and housing prices, those measures could show big bounces from month to month. Besides, homes are a strange hybrid of a consumable good and a long-term investment. As part of a long-running evaluation, 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 bureau."
The article included the chart below, which is quite revealing of the divergence between home prices and rents. Imagine what CPI would look like if it accurately measured the actual inflationary factors impacting consumers’ pocketbooks.
click for larger graphic
Chart courtesy of NYT
How does BLS determine this artificial measure? Via the Consumer Expenditure Survey:
"For the past 22 years, it has measured inflation in the cost of housing
in a rather indirect way. As part of its Consumer Expenditure Survey,
the bureau collects information from thousands of Americans about how
much they pay for rent. But because renters are only a small part of
the population, it also tries to measure how much homeowners are
essentially paying themselves in rent. To determine the so-called
owners’ equivalent rent, it asks homeowners how much they would have to
pay to rent the house in which they live. That figure constitutes about
23.2 percent of the Consumer Price Index, by far its largest component.
Food is 14.3 percent and transportation is 17.4 percent, for example."
Consider the governmental obligations that are tied to CPI: everything from COLAs to Social Security to Veterans Benefits. It shouldn’t be a surprise that its structural bias is towards under-estimation.
How Home Prices Can Be Hot but Inflation Cool
NYT, June 26, 2005