“In 1983, the Bureau of Labor Statistics began to use [for CPI] rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since “owners’ equivalent rent” is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.”

So what does owners equivalent rent really mean according to the BLS?

“(The) BLS asks each homeowner for their estimate of the house’s implicit rent and what occupants would get for their rent (how many rooms, etc.) if the owner did rent their home.”

When the Bureau of Labor and Statistics do their surveying for shelter index portion of CPI they ask the following question (verbatim):

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Man I would love to get one of these calls.

If you ask someone about their home value, that is something they probably know about, but if you ask someone about their house’s implicit rental equivalent is, now that is a different story. Most people do not understand the economics of rental properties well enough to give such an opinion. Furthermore, how many people living in Mc-Mansions can even contemplate what their monthly rent would even be when they live in a neighborhood that may not even have on housing unit that charges on a monthly rent basis?

I think Gjerstad and Vernon know what Hazlitt knew decades ago: inflation numbers are blatantly cherry picked and scrubbed to make it seem like the COLA estimates are much lower then they really are.

Furthermore the BLS states that, “Because rents are not volatile, the CPI can use a longer interval between pricing observations than it uses for other consumer items.” I guess we will have take that statement about volatility at face value.

Click here for more information regarding the housing index and CPI