Why aren't house prices included in CPI?

Question

Swedens central bank recently lowered their prime rate to -0.25% from -0.10% in an effort to avoid deflation.

At the same time, house and apartment prices are higher than ever, up 11% last 12 months, and up hundreds of percents the last 5-10 years. Measures are taken to avoid a housing bubble, like regulations on mortgage payments and so on, these are having an effect but the effects of a rapid rise in rate would be disastrous.

As I've understood, and I guess this might differ from country to country, the measure of inflation, CPI, includes prices for services and goods, but not for houses and apartments, why is that? In Sweden, rent for apartments and the bank rate are included in CPI, but the consumer isn't paying rate, they pay rate * house prices.

If house prices were included in CPI, we would definitely have inflation rather than deflation, so the right action would be to increase the prime rate, which would also lower house prices.

Answer 1

The CPI stands for a Consumer Price Index. As in the price of things that are consumed (at a particular moment in time). Real estate prices are not the price of something consumed because they contain the value of current housing consumption but also the capitalized value of future housing consumption. As such, including house prices would make the CPI a mixture of consumption at different times, and therefore unsuitable for comparing the price of consumption bundles at distinct times. Instead, they use a purer measure of the price of housing consumption: rents.

Rents reflect the price of consuming a flow of real estate services at a moment in time. Of course, many homes are owned by the occupants and not rented. Therefore, the calculators of national accounts generate something called "owner occupied rents", which is an attempt to calculate what the rents would be on homes that are occupied by their owners. This measure has problems, but for many purposes is quite adequate (Crone, Nakamura, Voith (2004)).

Answer 2

Rents are included in the CPI, because they are expenditures that are "consumed" in current period of time.

But house prices are not, because they are expenditures on an asset to be consumed over many years. If you own a house, you will benefit from the rising prices--if and when you sell it. In a sense, houses are treated like capital goods--for consumers. That is, rising house prices are not a burden to home owners, whereas rising rents are a burden to renters.

Answer 3

Experts argue that "raw" (i.e. the cost of actually purchasing a home) should never be included in CPI's because homes are not viewed as something people buy on a regular basis.

But that argument really becomes unstuck when you factor that reserve banks around the world use (WRONGLY in my opinion) CPI to determine interest rates.

The largest purchase for many people across the globe that relate directly to interest rates, is not shares, businesses, cars or any other similar investments, but homes. So it affects the prices of homes and their affordability directly through the setting of interest rates (remembering people need to borrow to buy a home in 99% of cases) and yet these same institutions and their simple minded economists refuse to take into account the growth of the same home prices when determining interest rates.

Inflation in real terms should be a measure of everything purchased in the economy whether it be a home, investment or bread.

Otherwise you have ridiculous situations globally as we have now where the indicators most economists use blindly are saying we have negative inflation, so interest rates are dropped and house borrowing and house prices go through the roof. If a housing market goes up 20% per year in some countries then should this not be included in the inflation rate? Because if house prices were included interest rates would be on the way up and not down.

We are currently being told by the "other" experts without vested interest in banking or housing sectors that the biggest problem in todays global economy is low interest rates fuelling asset bubbles (the biggest being residential housing in many countries). One way to fix this problem and easily is to start including house prices into CPI's and not burying our heads in the sand with ridiculous arguments as why not too. Yeh sure those in recent times who borrowed to much in a bubble asset class will take a massive hit. But it is a massive hit for the few that needs to happen for the better of the many in the medium to long term.