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March 05, 2005

Is Housing Inflation Inflating Growth?

The economy seems to be roaring forwards, with GDP growth reported to be stronger than expected in the fourth quarter. Yet it's always worth remember that growth measures are inflation-adjusted and are only as accurate as the measure of inflation. If inflation is actually larger than calculated, growth is lower.

And there is good reason to believe that the government is undermeasuring inflation, especially as it effects middle class families, the primary culprit being rapidly escalating housing prices. Unbelievable as it may sound, the most common inflation measurement, the CPI, does not include the cost of buying a house in its measurement of the cost of living. Historically, this didn't matter that much, since measured inflation and housing prices didn't diverge that much. But as this graph from The Economist shows (subscription needed), if you include housing in the calculation, real inflation is approaching 6% per year, not the 2% in the official inflation index:
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There are two ways to interpret this graph. Either the housing-related inflation is not real, because we are in a housing bubble and those increased prices are going to crash (which implies a whole host of other coming problems), or the housing prices are real, inflation is being undermeasured, and growth in inflation-adjusted terms is far less than currently being touted.

Posted by Nathan at March 5, 2005 01:25 PM