How the Government Deceives us on Inflation, as Rents and Housing Costs Soar

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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, 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], 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 rose 2.7% and rent 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. 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, 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). 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

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  9 comments for “How the Government Deceives us on Inflation, as Rents and Housing Costs Soar

  1. NotSoSure
    Sep 12, 2014 at 7:48 am

    Because the market knows that the Fed will NEVER raise interest rate?

  2. Vespa P200E
    Sep 12, 2014 at 9:37 am

    Feds have been manipulating the CPI and unemployment rate for quite some time both under Republican and Democrat POTUS.

    Obummer, purported self-claimed most transparent president ever, of course is masking/manipulating the CPI to another level. Fed’s biggest fear is that the lemmings will be protesting in the street (Ferguson many times over) if REAL CPI is exposed and demand raises, and for those who voted to Obummer demand classic price controls and worse more government handouts (which BTW is not working out in socialist paradise Argentina and Venezuela).

    Worst is that the government will be forced to up the ante on SS payments on the very system in verge of insolvency in next 10 years or so as more baby boomers join the ranks and live longer.

  3. Petunia
    Sep 12, 2014 at 11:59 am

    Every housewife in America knows the CPI is totally made up by the idiots in DC. We are out in the market place every day, paying for housing, food, gas, clothes, and entertainment. American women know that DC has been disconnected from the real economy for decades.

    • Sep 12, 2014 at 6:03 pm

      “American women” should speak up about this!!!! OK, they’re already doing it, but it needs to be louder.

  4. Frits
    Sep 12, 2014 at 1:19 pm

    Dear Wolf, I truly like your analysis that are from real live and not from cooked up Wall street/Government bullshit. My comment is that this all goes back to a simple statement = what you must buy is rising in price and what you not really need is declining. Unfortunately we have no choice on eating, renting/living, electricity and so on. So real inflation is much higher then stated. But that serves the agenda of the Government telling us we are ok. That is why QE is producing negative purchasing power for the ordinary people because rents, food etc are now all in a financial bubble not because of demand but of cheap finance and why Japan after 24 years of QE is experiencing a steep economic decline again.

  5. David R.(Canada)
    Sep 13, 2014 at 8:54 am

    It’s all very well to cherry-pick increasing prices in one area such as a large city. We can all think of a huge price increase somewhere in our lives.
    But if you factor in smaller communities then those increases are considerably less. In some cases prices and rents are dropping.
    The article above this one reports on how the prices in San Francisco are dropping (in the last 3-4 months) and here they’re talking about prices going up (over the last year)! My conclusion is that Wolf Richter must be bi-polar, or has a very bad memory.

    • Sep 13, 2014 at 9:32 am

      Not bi-polar. Just an observer in a complex world. No simplistic answers here.

      Real estate is local. Every community is different. A small town in Oklahoma won’t have the same dynamics as San Francisco.

      What you’re seeing is that there are not enough buyers out there at these prices. There is resistance to these prices, and sales at these prices have crashed. Now prices will have to go where demand is…. that’s the moment of truth. Southern California is there right now – as are other places.

      I live in San Francisco. In June, 2 units went up for sale within 1 minute walk from my place, where nothing had gone up for sale in years. One of them sold in late August. The other didn’t sell. Now a 3rd unit also within a 1-minute walk has gone up for sale….

      But housing costs on a national basis have soared over the past 12 months! That’s the basis for inflation.

      Like I said, this is a complex world.

    • James Kanabrosky
      Sep 16, 2014 at 5:37 pm

      Well, I live in Apache Junction, AZ, a damn small town, and my rent has gone up Five Times in Five Years, more often than a New York slumlord – so saying this is just a big city phenomenon leave me cold on rent day.

      • James Kanabrosky
        Sep 16, 2014 at 5:40 pm

        The thing about housing is that it’s not a luxury cost. You can’t say, “Oh, I don’t need a place to live.” As an absolute necessity, like medical care, it is not quite as subject to sane economic constraints. A “rational buyer” who is looking at homelessness is not rational.

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