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CPI Housing Cost Calculation Hides True Extent of Inflation

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The government CPI data for August came in slightly under expectations. Nevertheless, a 0.3% month-on-month increase in prices is significant. And a dig into the numbers reveals something wonky. The way the government calculates housing costs drastically understates rising prices and skews overall CPI to the downside.

Housing costs make up 1/3 of the CPI. If you’ve been looking to buy a home, or waded into the rental market, you know the price of housing has skyrocketed. Here’s some anecdotal evidence from a recent Facebook post.

Is it me or do you think the rental home market has priced medium income and retirees on a fixed income out of the area? I have close family and local friends looking for a single-family rental home with a long-term lease in the North Pinellas (Florida) area for under $2000.00 a month. They are non-existent. What is going on?”

And yet the CPI doesn’t reflect this huge increase in housing costs.

“Rent of primary residence” is the government’s estimate of rental costs and it makes up 7.6% of the overall CPI. It ticked up just 0.3% for the month of August. It has been running a monthly increase of 0.2% all year. Over the previous 12-month period, it rose a mere 2.1%. That’s just slightly above the 1.9% year-over-year increases in prior months.

But if you’ve actually searched for a place to rent, you know prices have skyrocketed far more than a couple of percentage points. The data bears this out. Apartment List’s rental index increased by 2.1% from July to August. That’s in just one month.  Since January 2021, the national median rent has increased by a staggering 13.8%. To put that in context, rent growth from January to August averaged just 3.6% in the pre-pandemic years from 2017-2019.

We see the same disconnect between the CPI measure for homeownership and the actual cost of buying a home.

“Owners’ equivalent rent of residences” (ORE) is supposed to reflect the costs of homeownership. It contributes nearly 25% of the overall CPI. The increase in “owner’s equivalent rent” inched up just 0.2% on the month and 2.6% year-over-year. This in no way reflects reality.

According to the National Association of Realtors, the median price of existing homes in the US spiked by 23% year-over-year. The Case-Shiller Home Price Index tracks the price change of the same house over time and serves as a pretty accurate measure of house price inflation. It has surged by 19% over the last 12 months.

Owner equivalent rent is supposed to reflect the amount of money a homeowner would have to pay in rent to live in the same house. The Bureau of Labor Statistics determines this number in a survey, asking homeowners, “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” It is literally nothing more than the opinion of the homeowner. It has virtually no correlation to the actual cost of the home.

The Bureau of Labor Statistics also calculates rent based on a survey. It asks renters the following question: “What is the rental charge to your [household] for this unit including any extra charges for garage and parking facilities? Do not include direct payments by local, state or federal agencies. What period of time does this cover?”

The problem with this measure should be obvious. It tells you how much the current renter pays, but it does not reveal how much the landlord would charge a new renter moving in today. The number understates rising rents, especially in periods of sharp increases.

The Bureau of Labor Statistics does try to account for this discrepancy using a complex formula. (The BLS even admits its complex, saying “The sample design of the Housing Survey is fairly complex.” But the bottom line is both OER and the rent calculation in the CPI are made-up numbers. They are calculated using made-up formulas plugging in numbers from random surveys. It’s no wonder they don’t reflect reality.

Peter Schiff summed it up perfectly.

For the government to claim housing costs are only up 2 or 3% year-over-year – that is ridiculous. And it is artificially suppressing the CPI rate because that is such a big component. Shelter is a third of the index. And that third, that number, is much lower than it should be if we actually plugged in real home prices or actual rents that people are really paying. Not the rents that the government is pretending people are paying.”

In fact, the entire CPI calculation is designed to hide inflation. Schiff has long said that the CPI data significantly understates rising prices. In fact, the government intentionally changed the CPI calculation in the 1990s in order to mask inflation.

According to the BLS, periodic changes to the CPI calculation are necessary because “consumers change their preferences or new products and services emerge. During these occasions, the Bureau reexamines the CPI item structure, which is the classification scheme of the CPI market basket. The item structure is a central feature of the CPI program and many CPI processes depend on it.”

In 1998, the BLS followed the recommendations of the Boskin Commission. It was appointed by the Senate in 1995. Initially called the “Advisory Commission to Study the Consumer Price Index,” its job was to study possible bias in the computation of the CPI. Unsurprisingly, it determined that the index overstated inflation — by about 1.1% per year in 1996 and about 1.3% prior to 1996. The 1998 changes to CPI were meant to address this “issue.”

In other words, the government changed the way it measures inflation to measure less inflation.

As Schiff pointed out, there is a lot of geometric weighting, substitution and hedonics built into the calculation. The government can basically create an index that outputs whatever it wants.

I think this period of ‘Oh wow! We have low inflation!’ It’s not a coincidence that it followed this major revision into how we calculate it.”

Simply put, we can’t trust these numbers. We all know prices are rising. And they’re rising much more than the official government numbers tell us. Keep that in mind when you hear Jerome Powell and other central bankers going on and on about “transitory” inflation.

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About The Author

Michael Maharrey is the managing editor of the SchiffGold blog, and the host of the Friday Gold Wrap Podcast and It's Your Dime interview series.
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