4 BRs, $29,750 a Month: A Story of Inflation and Bad BLS Inflation Estimates

Is the Bureau of Labor Statistics measuring price inflation correctly? Mark Gimien explores the question at Bloomberg News (my highlights):

Extraordinary as a [New York City] rent of $29,750 a month may seem, the rise in the price of a rental at the San Remo is not exceptional. You can find similar or even bigger increases at every level of the market, down to the most ordinary middle-class apartments. Looking closely at rents at the San Remo and other places in New York opens up questions about whether we’re measuring inflation accurately. And those questions, in turn, have big implications for how we understand the cost of living and quality of life—not only of those who live in the San Remo, but of the middle class.

Nationally, according to U.S. inflation data, since 1940 rents have risen 1,014 percent, so they have gone up about 11-fold. For the New York area alone, the increase is a little higher, 1,250 percent. Though those are big numbers, they’re actually lower than the overall 1,536 percent rise in prices reported by the Bureau of Labor Statistics, the agency that gauges inflation. 

Most New Yorkers, however, would guess that the price of housing has risen much faster. Diving deep into old records bears that out. The 1940 census found the median rent in New York City to be $38.10. In 2011, that was $1,100. That’s an increase of 2,787 percent—close to twice the rate of inflation. And when you start comparing specific apartments, delving into the newly released 1940 census forms in which I found how much Meno Henschel paid for his apartment, the differences are even starker. 

At the San Remo the price increase is greater than 50 times. It’s a good example, because the San Remo is one of very few buildings not to have changed in character over 70 years. It was, as Dennis Hughes, the real estate agent handling the listing puts it, an “iconic” building then, and it remains so now. It’s a time capsule of luxury living. But that kind of increase hasn’t happened just at the top. You can see the same pattern in much more modest places.[...] 

So what’s happening here? Most conventional stories of inflation hold that the consumer price index tends to overestimate how much prices rise. For a long time, the index, the government’s main inflation yardstick, didn’t adjust for changes in quality, and many economists believe that it still doesn’t do it enough. 

With rent, it’s a different story. Rent is a particularly important piece of the consumer price index. The government uses data on rents not only to estimate inflation for those who actually rent their homes, but also to separate out the investment value of homes and derive a measure of how much homeowners pay to keep a roof over their heads. Together, “rent” and “owner’s equivalent rent” make up about 30 percent of the inflation measure.[...] 

Perceptive recent work on rent comes from three economists who worked together at the Philadelphia Federal Reserve, Theodore Crone, Leonard Nakamura, and Richard Voith (Nakamura is a vice president of the Philadelphia Fed). Their research makes a good starting point for figuring out the rent puzzle. 

The most important insight in their work is that for decades the inflation measures skipped over the cases in which a tenant moves out. Think about that for a second: A landlord avoids raising the rent for a decade for a good tenant, then when the tenant moves, ups the rent to a market rate. Or, as is common in New York, rent regulations keep rent from rising until a tenant moves out. Those are precisely the units in which the rent is most likely to rise, and for some four decades they weren’t counted in inflation. 

Crone, Nakamura and Voith estimate that this and other problems bring down the government’s measure of rent increases by about 1.4 percent a year for the whole period that runs from 1942 to 1985. Nakamura outlines these findings in a very readable paper published by the Philadelphia Fed. Over such a long period, 1.4 percent turns into a really big number. Add that in, and instead of falling 20 percent in real-dollar terms over six decades, rents rise 50 percent.

Think about what that means for the middle class. Since 1970, the average hourly earnings of American workers (excluding managers) have stayed almost exactly flat by the official inflation measure. If, however, the cost of housing has risen faster than those measures say, then that means that many folks are actually worse off than they were then.