Business Economics • January 2006 59 Focus on Statistics FOCUS ON STATISTICS Housing Costs In the CPI: What Are We Measuring? The treatment of owner-occupied housing in the Consumer Price Index has long been a subject of confusion and consternation. Thus, a session to explore the issues was organized at the National Association for Business Economics Annual Meeting in Chicago on September 26, 2005 The following three papers were presented at that session. Is It Time to Change the Method? By Joseph G. Carson Joseph G. Carson is a U.S. Economist and Director of Global Economic Research, Alliance Capital Fixed Income. T he housing measurement in the consumer price index (CPI) has been debated for the past 50 years and is once again coming under intense scrutiny. Despite the housing market’s explosive growth and the rapid rise in home prices, the housing- cost component of the CPI has shown the smallest increase in many years. Before we review the current method of measuring this component and propose changes, it would be pru- dent to review the debate and meas- urement changes since the early 1950s. This should provide a better understanding of why a housing-cost index was included in the CPI in the first place, why it was changed in the 1980s, and why another change may be appropriate today. Housing Costs and CPI Time Line In the CPI’s early days, only a few select types of housing expenses, such as rent and utilities, were included. But in the early 1950s, a debate began over whether to include other expenses, such as the cost of purchasing and financing a home, given the changing characteristics of the housing market. A time line of the evolution of this debate is shown in Figure 1. The debate was triggered by shifts in the housing market. Following World War II, there was a dramatic rise in homeownership, and by the early 1950s, more than half of all households owned a home. As a result, the Bureau of Labor Statistics (BLS) decided to broaden its defini- tion of housing to include items tied to home ownership, and not just home renting. Starting in 1953, a separate housing-cost index based on the asset-price approach—which includ- ed the price of the asset and the cost of money used to purchase the asset—was introduced into the CPI. Although the shift went smoothly, the debate did not end. In 1961, the Price Statistics Review Committee of the National Bureau of Economic Research made a number of recom- mendations concerning the CPI after reviewing all price statistics. One important recommendation was that the BLS consider shifting from the FIGURE 1 TIMELINE OF DEBATE ON HOUSING COSTS AND THE CONSUMER PRICE INDEX 1970s 1977 1980 1983 1987 1997 2005 1950 1953 1960s Housing costs included in CPI market basket Stigler committee recommends BLS investigate creating a “rental equivalence” index (BLS disagreed; rental equivalence not justified in a price index) Housing index creation due to rise in homeownership rates BLS staff proposed creation of user-cost index to measure housing Academic economists, government statisticians, business and labor groups reject proposal BLS proposes five experimental measures for housing BLS introduces new housing sample with both owner- and renter- occupied units BLS implements rental- equivalence index into the CPI; CPI house price no longer representative of the market BLS drops owner sample — could not find enough units to match characteristics of owner-occupied housing Housing costs based entirely on rental market despite homeownership rates at record 69 percent Source: Alliance Capital Fixed Income