Home prices and inflation

In today’s Economic Perspective, N.C. State University economist Mike Walden explains how home prices figure into the calculation of inflation.

“It used to be that the government did try to take home prices and put them into the inflation calculator.  But then they realized … that … doesn’t make sense, because people don’t buy a house every day. … So, what the government now does is they use what they call a rental equivalent for homeowners.

“In essence, they say the cost for the Waldens, for example, of the home that we own is what we could rent it out for. And they put that into the measure, along with the other prices of inflation.

“But this can actually cause some strange things to happen. For example, when home prices were rising very rapidly about 10 – 5 to 10 — years ago, rents were not. In fact, rents were going up at about an average rate. So, our inflation gage did not capture those very rapidly rising home prices and perhaps gave our policy makers wrong information on really how bad inflation was.

“Now we’ve got the opposite.  Home prices are going down. Rents aren’t. And so our inflation measure isn’t picking up those lower home prices.

“So, this is a tricky issue, and there’s really no perfect solution other than for people to be aware of how uniquely home prices are counted in inflation gauge.”