How Housing Lowers CPI

Tony Crescenzi had an interesting article on RealMoney this week. In it, he notes that as the housing market soars, it ends up knocking rents lower. After all, why rent if ultra low real interest rates allow you to buy for the same price, and with nearly no money down?

So what’s the problem with that? It turns out that rental prices account for 30% of the core CPI. As we saw last month, this was zero flat.

How’s that impact the perception of inflation? Crescenzi observes:

“Surging housing demand appears to be continuing to reduce demand for rental units, weighing on the OER component of the CPI. Strength in housing demand is apparent in the recent data on mortgage applications for home purchases, wherein the four-week moving average is now at a record high, as well as the National Association of Homebuilders’ latest housing market index, which in May reached its second-highest reading in five years. Meanwhile, rental income has fallen to about $147.8 billion from the peak of $186.6 billion in April 2002. When the housing market weakens, it will result in increased demand for rental units, hence boosting the OER portion of the CPI.”

The Federal Reserve commissioned a 52-page study on the subject. In it, they discussed the impact of housing demand on the OER component of the consumer price index. They found:

“Downward pressure on rental prices mainly resulted from an increase in demand for homeownership, which was spurred by historically low mortgage interest rates (see Figure 19). As housing starts and home sales surged in the recent recession and recovery, the national rental vacancy rate jumped from 7.8 percent in the fourth quarter of 2000 to 10.2 percent in the fourth quarter of 2003. This effect was compounded by the way owner-occupied housing prices are measured in the CPI. The CPI uses a rental-equivalence approach, measuring the value of the shelter services an owner receives from his or her home. Price movements in owners’ equivalent rent reflect changes in prices of rental units that are comparable in characteristics to owner-occupied homes. Therefore, increased demand for homeownership put downward pressure not only on tenants’ rent but also on owners’ equivalent rent — the largest component in the CPI.”

Figure 19
click for larger chart


Crescenzi adds this coda:  “Note that when mortgage rates go up, demand for new homes presumably falls, hence boosting the demand for rental units and thus boosting rental costs and the CPI.”

That’s right folks, the low reported inflation is courtesy of a hot housing market. As most people have figured out for themselves, inflation is still alive and kicking..



How Housing’s Surge Is Suppressing CPI
Tony Crescenzi, 5/18/2005 12:59 PM EDT

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Froth vs Bubble

Anyone looking for some clarity from Federal Reserve Chair Alan Greenspan on whether the United States Real Estate market is in a speculative bubble is probably asking the person least likely to provide a clear and understandable answer. 

Well, do we or don’t we?

Well, yes kinda, but not really, no.

That was Big Al’s answer to the question of whether we have a housing bubble in the U.S. or not.

"There are a few things that suggest, at a minimum, there’s a little froth in this market. We don’t perceive that there is a national bubble, but it’s hard not to see that there are a lot of local bubbles," Greenspan opined to the Economic Club of New York.

O.K., frothy, no national bubble; yet lots of smaller bubblettes. (Recall our prior bubblette discussion in February).

But don’t breathe to deeply just yet. Greenie noted that asset gains in Real Estate are unsustainable: 

"Without calling the overall national issue a bubble, it’s pretty clear that it’s an unsustainable underlying pattern. What we see are a number of forces, which are, as far as I can judge, not infinitely projectable."

Got that? Let’s review: Not a bubble, but Unsustainable. Not a national bubble, but local bubblettes.

Thanks for clarifying that for us . . .


UPDATE MAY 22,2005   6:36am

Alan Abelson had a few choice words on the Fed Chief’s prognostications here. He equates Friday’s speechifying to the infamous 1996  "irrational exuberance" speech. (So we got that going for us, which is nice).


Greenspan Calls Home-Price Speculation Unsustainable
Craig Torres, Alison Fitzgerald
Bloomberg, May 20, 2005 18:04 EDT

Greenspan sees no housing bubble
Federal Reserve chairman says sector shows sign of
‘froth’ but doesn’t perceive a national bubble.
Reuters, May 20, 2005: 3:08 PM EDT

A Bubble in the Housing Market? Any Implosion Won’t Be Obvious
Ken Brown
The Wall Street Journal, May 20, 2005,,SB111662227079239476,00.html

Greenspan Is Concerned About ‘Froth’ in Housing
NYTimes, May 21, 2005


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