1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/5183/so-now-its-core-core-inflation/

So Now It’s Core Core Inflation?

June 14, 2006 by

For the third month in the row, “core” consumer prices, which the Fed and accordingly also financial markets have decided to focus on ( for irrational reasons ) showed a 0.3% increase, which translates into an annual rate of more than 3.5%, well above the official comfort zone.

The driving factor behind this recent pick-up in “core” inflation is the fact that rents have started to increase at a much faster rate (largely because the combination of higher house prices and higher interest rates have made home ownership increasingly unaffordable), and as rent and “owners’ equivalent rent” (which is based on rents) make up 29% of the CPI or 38% of “core” CPI, this have a great effect on these numbers.

With even “core” inflation numbers showing high inflation, what are inflation-deniers supposed to do? Well, they simply come up with one might call core core inflation, that is, core inflation excluding rent and “owners’ equivalent rent”, with for example Ian Shepherdson, U.S. Economist for High Frequency, reassuring us that by excluding the numbers are still moderate. That would of course leave us with a “true” CPI consisting of just 48% of all items. If I didn’t know better, I would be tempted to assume that they’re attempting to do self-satire.

Yet, while they are right to imply that “owners’ equivalent rent” distort cost increases for home owners, the distortion is still to underestimate, not overestimate (This may change if the housing market goes into a dramatic fall, but again, it have not yet happened). While “owners’ equivalent rent” have risen 3.3% the latest year, house prices have risen 12.5%.

{ 12 comments }

Yancey Ward June 14, 2006 at 12:23 pm

I guess they can always point to the one item in the basket that showed the least increase and call that core.

Does anyone know if apple cores have any value?

Person June 14, 2006 at 12:29 pm

Stupid questions: Wouldn’t increasing interest rates drive *down* home prices, as people revise down their bid offers to adjust for the lower payments they can afford at given interest rates? And aren’t increasing interest rates *good*, given that the Fed’s role is basically that of making borrowing artificially cheap?

quasibill June 14, 2006 at 12:41 pm

Person:

“Wouldn’t increasing interest rates drive *down* home prices, as people revise down their bid offers to adjust for the lower payments they can afford at given interest rates?”

Ceteris paribus, yes, and this is the important part – over time. People, especially speculators, still believe that their homes will continue to appreciate. So they’ll hold on to erroneous valuations for a long time – refusing to sell at the going rate. Meanwhile, some people will still be willing to “overpay”. So the market price won’t immediately react to the change in rates. There are other reasons for the lag, as well.

And that all neglects the impact on consumers and entrepreneurs who reacted to the false market signals generated by the artificially cheap credit during the boom. As housing prices level off or drop, they’re holding more debt, and less equity, than they expected. Of course, some amount of this is natural – mistake happen. But more mistakes happen when the market signals are distorted by state action, so the eventual correction is more painful.

“And aren’t increasing interest rates *good*, given that the Fed’s role is basically that of making borrowing artificially cheap?”

Well, if we knew what the natural rate of interest was, it would be. But since we can’t, really, it’s neither good nor bad in absolute terms. However, you can recognize the inevitable result of jacking up rates artificially after you have artificially lowered them. The artificially lowered rate causes lots of bad debts to accumulate. The raising of the rate artificially causes people holding these debts to lose their ability to finance the debts, causing defaults. So to some extent, raising the rates helps cure the problems caused by lowering them, but at the same time, it is unlikely, if not impossible, that the rate will be set to the natural rate, which just means more distortions.

nodoodahs June 14, 2006 at 1:11 pm

Let’s set aside for a moment the fact that inflation is monetary and that rising prices are the result of inflation and not inflation itself; let’s also set aside all of the OTHER flaws in CPI and focus briefly on housing costs.

During a housing bubble, housing prices rise very quickly, and houses are purchased by more marginal buyers (who would otherwise be renters), which decreases demand for rental housing and depresses rents. Further depression of rental rates occurs when the late bloom of speculative buyers purchases homes for landlording purposes. These late speculators are content to rent for less, even to be cash flow negative, because they feel they will make it up on appreciation.

After the housing bubble, as housing prices depress and mortgage rates rise, there is less demand from the marginal buyer. Add to that overleveraged consumers who may need to lose their ARMs, and demand flip-flops into a push for higher rents. Finally, the stretched landlord feels a need to maximize his rents since he can no longer count on appreciation.

Ergo, during the housing bubble a CPI constructed on “owners’ equivalent rents” will not fully capture the cost of homeownership, and after a housing bubble starts to collapse, a CPI constructed on “owners’ equivalent rents” will overestimate the cost of homeownership.

Person June 14, 2006 at 2:11 pm

quasibill: I wanted to first thank you for your reply. You addressed specifically what I asked and did not falsely attribute any statements to me. After that IP thread, such treatment is, in a very real sense, a Godsend.

Your reply about the relationship between interest rates and real estate prices makes sense, but it still shows Karlsson’s comments to be in error. As for what the interest rate “should” be, I agree. No one can “work some numbers” with omniscience and know what it should be. I’m just relying on intuition here. Given the general shortening of time horizons we’ve seen recently, and how people are going obscenely in debt, it just makes intuitive sense that interest rates should not be pitifully low. Plus, I’m one of those saving types ;-)

Sione June 14, 2006 at 8:15 pm

Two things you have to remember about savings.

1/. Know where to save.

2/. Hide your accumulated wealth.

Once the morbidly indebted realise their true situation, and start to suffer, they will clamour for relief. Anything will do. Just bring the easy living and reduce the pain. And your good mates in the govt will listen. Guess where the wealth to take away all that pain is located. Your savings.

Sione

David C June 14, 2006 at 9:55 pm

nodoodahs: … Finally, the stretched landlord feels a need to maximize his rents since he can no longer count on appreciation.

Ergo, during the housing bubble a CPI constructed on “owners’ equivalent rents” will not fully capture the cost of homeownership, and after a housing bubble starts to collapse, a CPI constructed on “owners’ equivalent rents” will overestimate the cost of homeownership.

I’m not sure that’s true. When San Diego had a slow down in 92, it drove down rents and housing. Rent isn’t driven by landlord maximization, but by supply and demand. Demand will probably go down in economic harsh times where pay doesn’t keep up with inflation. In addition low interest house financing encourages overbuilding, so when times get harsh, more people who didn’t sense a need to rent out their properties before will sense a need rent now to simply take what they can get and saturate the market.

IMHO, Both low end rentals and high end rentals will be driven down by bad economic conditions. However, low end rentals will have counter pressure from people moving out of expensive houses to less expensive rentals, whereas high end and house rentals will have no counter pressure.

Also, this is *not* going to be like a normal hyperinflation. What will likely happen is that things that foriegners compete for (like commodities) are going to explode in price, while things like pay and housing will not. It will be like stagflation on steroids. Rising prices, overseas labor, and technology deflation will make it harder to pay down debts and increase revenues. At the same time foriegn competition for limited resources, and a huge ammount of dollars floating arround will drive commodity prices sky high.

mark June 15, 2006 at 6:23 am

With the need for foreigh entities to hold U.S. dollar currency reserves to purchase oil on world markets and to stave off foreign currency runs, what’s wrong with the U.S. Federal Reserve taxing those reserves by devaluing the dollar from the perspective of the U.S.?

The Federal Reserve will continue to tax foreign holdings of U.S. dollars at rates greater then a return on those reserves would justify. The only way for foreign entities to reverse this course would be to purchase more goods and services from the U.S.

Until then, what’s wrong with the devaluation policy from the perspective of the U.S.?

nodoodahs June 18, 2006 at 8:50 am

The 1992 San Diego slowdown was caused by specific economic conditions of that area, and as such was similar to slowdowns in housing caused by the end of the oil boom in the late 1980′s in Texas, and other region-specific slowdowns. Those phenomena will slow down housing prices and rents simultaneously as they impact the entire economy of the region first, and the secondary reaction is in housing.

What we’re experiencing now is not a change in the rate of housing appreciation caused by an economic slowdown in a region, but rather a change in housing appreciation caused by a change in monetary policy. Changes in the economy overall are tertiary to the monetary/liquidity changes and the housing appreciation changes.

In sum, the two types of slowdown are different.

Alan Reynolds June 19, 2006 at 8:55 am

There is a serious argument for using a chain-weighted price index and for excluding the relative price or energy when evaluating whether or not monetary policy is at fault (rather than, say, real global economic activity). In my latest column I mention two Fed studies that found the CPI ex-energy predicted sustained inflation trends better than alternatives — particularly the CPI with energy included.

http://www.townhall.com/opinion/column/alanreynolds/2006/06/15/201663.html

nodoodahs June 19, 2006 at 2:13 pm

Alan, I feel the need to remind you that inflation is monetary and that rising prices are the result of inflation and not inflation itself; therefore an argument might be made that CPI ex-energy may be a better predictor of sustained trends in CPI, but CPI is not the same thing as inflation.

I was hoping to avoid issuing the inflation rant and confine the discussion to impacts on, and manipulations of, CPI statistics, but it behooves us now to review what inflation really is.

When we refer to “inflation” or “deflation”, when we really mean CPI, or equity prices, or general price levels, etc., we are doing the government’s work for them. They have been on an intentional campaign for decades to divorce the concept of money supply from the fact of rising prices. They do this to hide their part in our economic woes – the fact that they rob us through monetary policy on a daily basis. I’ve been on this board a few times with “CPI is a lie” messages and the points taken in the article should not be new to any of you. We should not let the enemy win the war of words!

My Webster’s College, Home, and Office Dictionary (Self Pronouncing) published in 1929 doesn’t even have the word “inflation.”

Since in 1929 the Fed had only been in existence for 15 years, we still had a gold standard, and we still had legal ownership of bullion coin (not to mention that all minted coins had specie value), this may not be surprising. The 1929 dictionary does have the word “inflationist” meaning “one in favor of an increased issue of paper money.”

My Webster’s New World Dictionary published in 1962 has the word “inflation” meaning “1. an inflating or being inflated. 2. an increase in the amount of currency in circulation or a marked expansion of credit, resulting in a fall in the value of the currency and a sharp rise in prices.”

My Webster’s College Dictionary published in 1991 has the word “inflation” meaning “1. a steady rise in the level of prices related to an increased volume of money and credit and resulting in a loss of value of currency (opposed to deflation). 2. the act of inflating. 3. the state of being inflated.”

In the vernacular, “inflation” means “higher prices.” Why this shift? Take a look at this definition: “Inflation has been defined as a process of continuously rising prices, or equivalently, of a continuously falling value of money.”

Did that come from Webster’s 2005 edition? No, it came from http://www.bls.gov/bls/glossary.htm#I.

Don’t let them win the war of words. Once they do, we will have lost the war of ideas.

End of inflation rant.

Now back to the topic of whether CPI ex-energy is a better predictor of CPI than CPI itself – my P.O.V.? I don’t care. CPI is a manipulated figure that in and of itself means nothing. I pay attention only to the extent necessary to gauge market reaction to the “numbers” and to try and find profits resulting from the market’s reaction.

rob July 13, 2007 at 7:49 am

some home builders such as ryan homes uses phases in
development to artificially create home values to rise. Also,
many property taxes/school taxes increase each year. thus,
feeds on inflation…thus, in long term, home prices and
commercial buildings are good investments…you get a
subsidized tax break from uncle sam…and your value increases.
you can one day cash out by buying gold or keeping your
money in CD’s. trick is to pay off the debt as quickly as possible.

Comments on this entry are closed.

Previous post:

Next post: