Accounting for Housing in a CPI

28 Pages Posted: 25 Mar 2009

See all articles by W. Erwin Diewert

W. Erwin Diewert

University of British Columbia (UBC) - Department of Economics; National Bureau of Economic Research (NBER)

Alice Orcutt Nakamura

University of Alberta - School of Business

Date Written: March 1, 2009

Abstract

In this paper, we take stock of how statistical agencies in different nations are currently accounting for housing in their consumer price indexes (CPIs). The rental equivalence and user cost approaches have been favorites of economists. Both can be derived from the fundamental equation of capital theory. Concerns about these approaches are taken up. We go on to argue that an opportunity cost approach is the correct theoretical framework for accounting for owner-occupied housing (OOH) in a CPI. This approach, first mentioned in a 2006 OECD paper by Diewert, is developed more fully here. We explore the relationship of this new approach to the usual rental equivalency and user cost approaches. The new approach leads to an owner-occupied housing opportunity cost (OOHOC) index that is a weighted average of the rental and the financial opportunity costs.

We call attention to the need for more direct measures of inflation for owner-occupied housing services. In a 2007 paper, Mishkin argues that central banks with supervisory authority can reduce the likelihood of bubbles forming through prudential supervision of the financial system. However, the official mandates of central banks typically focus on managing measured inflation. Barack Obama has pledged to give the Federal Reserve greater oversight of a broader array of financial institutions. We believe that an important addition to this pledge should be to give the BLS, BEA, and Census Bureau the funds and the mandate to aggressively develop improved measures of inflation for owner-occupied housing services. Central banks and national governments have many policy instruments at their disposal that they could use, in the future, to control inflation in housing markets. What they lack are appropriate measures of inflation in the market for owner-occupied housing services. The proposed new opportunity cost measure for accounting for OOH in a CPI will not be simple or cheap to implement. However, the current financial crisis makes it clear that the costs of not having an adequate measure for inflation in the cost of owner-occupied housing services can be far greater

Keywords: Durable goods, Consumer Price Index, Cost of Living Index, Owner Occupied Housing, depreciation, hedonic regression models, rental equivalence approach, acquisitions approach, user cost approach, payments, approach, maintenance and repair, renovations expenditures

JEL Classification: C23, C43, C81, D12, E31

Suggested Citation

Diewert, W. Erwin and Nakamura, Alice Orcutt, Accounting for Housing in a CPI (March 1, 2009). FRB of Philadelphia Working Paper No. 09-4, Available at SSRN: https://ssrn.com/abstract=1367631 or http://dx.doi.org/10.2139/ssrn.1367631

W. Erwin Diewert (Contact Author)

University of British Columbia (UBC) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Alice Orcutt Nakamura

University of Alberta - School of Business ( email )

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Canada

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