Wolf Richter www.wolfstreet.com [8] www.amazon.com/author/wolfrichter [9]
It’s hard these days to worry about inflation amidst a maelstrom of voices claiming that there isn’t enough inflation to begin with, and that the world will end if prices stop rising even for a moment. Whatever inflation we may encounter in daily life, whether for healthcare, tuition, beef, gas, or cars, we’re told not to worry about it because the higher prices are either annulled by an elegant scheme called hedonic regression [10], or they’re only temporary, or the amounts are too small to impact the overall budget.
But when it comes to housing, which now accounts for 33.6% of what Americans spend [What’s Draining American Wallets? Interactive Chart [11]], none of these excuses fly. Because inflation in housing has been red-hot.
Actually, it hasn’t been red-hot, the way the Bureau of Labor Statistics measures it. Its Consumer Price Index contains two housing components: “Owners’ equivalent rent of primary residence” (OER) and “Rent of primary residence” (Rent). They purport to measure the cost of “shelter,” which is the “consumption item” that a home provides and is thus included in the CPI. The cost of the home itself and any improvements to the home are considered an “investment,” not consumption, and therefore not part of the CPI.
Owners’ equivalent rent accounts for 23.83% of the CPI and rent for 5.93%, for a combined weight in the CPI of about 30%. It is by far the largest and most important component.
Inflation in these two categories was contained, as they say at the Fed. In July, owners’ equivalent rent [12] rose 2.7% and rent [13] rose a minuscule 1.0%.
And in reality?
Home prices rose 8.2% over the 12 months through June 2014 and 12% for the prior 12-month period, according to the Case Shiller 20-City Index [14]. A far cry from the government-sanctioned owners’ equivalent increase of 2.7%.
And rents? They rose on average 6.3% in August from a year earlier, according to Trulia [15], with double-digit gains in five of the 25 largest rental markets: in Sacramento, rents soared 14.9%. In San Francisco, where the median rent for a 2-bedroom apartment is now $3,500, they jumped 14.5%. That $3,000 apartment a year ago would now cost an additional $435 a month, or an additional $5,220 a year! No inflation, no problem. In Oakland, rents jumped 14.4%; in Denver, 13.1%; in Miami 11.3%. In the 25 largest rental markets, rents soared on average 10%.
How can our trusty government be so far off the mark?
The data are obtained by survey. For “owners’ equivalent rent,” owners are asked what they think they would have to pay if they were renting the home. Hence a measure of implicit rent. For the “rent” component, renters are asked what they’re currently paying in rent. Even if they’ve lived in a rent-controlled apartment for 20 years and pay a ludicrously low rent, it becomes part of the statistics, and not the rent that a new renter would have to pay.
Surveys are easy to manipulate, in numerous subtle ways, and that’s why they’re used to determine shelter costs. The BLS could instead use market rents, which is a common measure of actual rents negotiated between renters and landlords at the signing of the lease. Each time a new lease is signed, it impacts market rent. But that would, like Trulia’s measure, indicate just how fast rents are rising. So, no way.
How large is the deceit? Over time, it adds up. From 2011 to 2014, market rent rose by 12.1% while owners’ equivalent rent inched up only 4.7%. OER understated actual rent inflation that people felt in their bank accounts by 61% in a little over three years.
Housing accounts for 30% of CPI, and understating inflation in housing will cut overall CPI by a big chunk. Actual inflation in housing costs is still there, but you can’t see it in the official numbers, on the government principle that hidden inflation is the best inflation.
It eats up your bank deposits and your wages and the value of your Treasuries and everything else you own. It pushes you into higher tax brackets though tax brackets are indexed to CPI – the hidden bracket creep.
Any government or corporate programs, pensions, and benefits that are indexed to CPI will gradually become less costly to the government or the corporation, and less valuable to you. The savings to them over time are huge. And best of all, understating inflation overstates “real” economic growth as measured by inflation-adjusted GDP. It’s the perfect solution for economies that are mired down.
Consumers, workers, and taxpayers are getting shafted without knowing about it. And the Fed doesn’t use CPI as inflation gauge for its purposes. It uses PCE, which understates inflation even more (chart [16]). And so it can carry on its scorched-earth monetary policy while loudly proclaiming that inflation is below “target.” Hidden inflation is simply perfect.
Nevertheless, the Fed has embarked on a rate-hike cacophony. But ebullient markets are in no mood to listen and are pricing in “a later liftoff date” for the federal funds rate and a slower pace of tightening than FOMC participants themselves, the Fed finds. And it frets that the disconnect could cause financial instability. Read… To Avert Sudden Market Collapse, the Fed Tries to Spook Utterly Unspookable Markets [17]