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November 29, 2003

Is Growth Real II?

If inflation is being underestimated, then the inflation-adjusted growth numbers we've seen reported are overestimating growth.

On top of the "quality" adjustments I noted, there is a fundamental problem in the inflation statistics related to the housing market.

As this CNN/Money article details, a serious problem with inflation measures is that they include changes in the cost of rental housing, but do not take account of increases in housing prices for home owners. The assumption is that even home owners are merely saving the costs of renting their homes, so the numbers are substitutable.

In most periods, the two numbers go up together, but at the moment, rental prices are dropping, even as home purchasing costs continue to rise. The result is that the housing portion of the CPI inflation number -- 22% of the total - has grown at just 2.1 percent over the past year . Unless there is a coming crash in housing prices, this number is just unrealistic in accounting for the increased costs of purchased housing.

This low housing portion of CPI disguises sharp increases in other prices:

The Commodity Research Board's index of commodity prices touched a new 6-1/2 year high Thursday. The industrial materials index administered by the Journal of Commerce and the Economic Cycle Research Institute is rising at a 33.7 percent annual clip...

From September of last year to September this year the cost of education, according to the CPI data, has risen 7 percent. Medical costs are up 4 percent, utilities are up 8.6 percent. All of these much higher than the overall CPI, which grew at just a 2.3 percent rate, and the "core" CPI, which excludes food and energy prices because they're so volatile, and which grew just 1.2 percent.

So if the housing price component is distorting the real measure of inflation, real inflation-adjusted growth is much less than what's being reported.

Update: More on this subject here:

In the past 12 months the annual increase in the core CPI has fallen by 0.9 percentage point. Exactly half of that decline can be attributed to one component: the imputed rental value of a home, otherwise known as owners' equivalent rent (OER)

And if you want a more conspiracy-oriented view of inflation understatement, check out this article. Now, the statistical agencies have a pretty good reputation for independence, but the article does emphasize the institutional pressures to understate inflation at this point, even beyond making Bush's economy look better:

government expenditures are tightly coupled to the rate of inflation. Programs like Social Security and government wages are tied to increases in the cost of living. Some government bonds have their interest rates determined by the CPI...So... by understating inflation the government saves billions and billions of dollars. In this age of soaring deficits, understating inflation is an important tool for the Government to save money.

Posted by Nathan at November 29, 2003 01:41 PM