The Official Inflation Measure Is Totally Blowing It On Housing Costs

Matthew Yglesias makes a good point:

For many purposes, including monetary policy, the federal government needs a statistical series to calculate the level of inflation in the economy. Since food and energy prices, though important to consumers, are highly unstable and deeply driven by non-monetary factors (weather, political upheaval) it's conventional to strip those out when assessing short-term monetary policy. But when you strip out food and energy prices, then a very large share of the remaining "core" CPI is the price index for housing. And calculating the price index for housing is conceptually complicated because only a non-random minority of people rent, so you can't really just go around and tally up rents.

Adam Ozimek has a paper pointing to what he and I agree is a major practical failing in the way the Bureau of Labor Statistics currently handles this problem[...]
My effort to make this issue a bit more digestable:

How Does The BLS Calculate Inflation For Owner-Occupied Housing Now?They completely ignore issues about the sale price of houses and prevailing mortgage rates and instead "impute" rental value. Which is to say the question the BLS seeks to answer about your condo is not "how much would it cost someone else to buy your condo" but "how much money are you saving by living in your condo rather than renting an identical one." Equivalently, they're asking how much you could earn as a landlord if you started sleeping in your car and renting the house out. So what the BLS does is it surveys the prices that renters are paying for housing, tries to do quality adjustments as it does for all other kinds of goods, and then imputes an equivalent rental value to all the owner occupied housing[...]

What's Wrong With The Current Approach to Imputing Rents? The issue is that rents for continuously occupied structures are generally quite sticky. One can debate exactly why this is, but it's clearly true and you see this very much in gentrifying urban neighborhoods these days. Look at someone in DC who's been renting a house in Shaw in DC since 2006 and she is almost certainly getting an outrageously good deal from her landlord compared to what someone trying to move into the neighborhood in 2014 would pay. The landlord fears that if he tried to raise the rent all the way up to the current market price that he would wind up with (a) several months' worth of vacancy and (b) runs the risk of acquiring a problem tenant. Consequently, in an area where rents for new tenants are rising quickly theaverage rent paid will rise more slowly (and vice versa in a downturn).

What Are You Saying We Should Do About This? The proposal is to ignore average rents for the purposes of imputing rent to owner occupied housing, and just focus on new rents. In other words, impute rental value to DC homeowners on the basis of what someone who just moved to DC would have to pay to rent a dwelling rather than on the basis of what existing residents are actually paying. That would create a housing CPI that fluctuates up and down more rapidly in response to changing conditions.

The full article is here.