Download Inflation Following an Housing Boom

Housing Booms,
Inflation Measurement,
and Monetary Policy
Stephen G. Cecchetti
Brandeis International Business School
US Housing Price-Earnings Ratio
(Value/Rent)
20
2006Q2 = 18.5
18
16
14
1978-1999 Average =14.2
12
19
52
19
55
19
58
19
61
19
64
19
67
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
20
06
10
Source: Federal Reserve and BEA
The Impact of Housing Booms
 Housing and Macroeconomic Performance


Closer to 100% of GDP and widely held.
Wealth effects tend to be large (too large?)
 Housing Booms 


Lower growth
Higher inflation
3
Impact of Housing Booms on
the Distribution of Output and Prices
Log Output
Relative to Trend
Quarters Ahead
Mean
Variance
8
-0.50
4.75
12
-1.28
1.93
Housing Booms:
Output: Lower average, higher variance, worse tail
Prices: Higher Average
Log Price Level
Relative to Trend
8
1.14
0.60
12
0.95
0.87
Tails of the Distribution
 Risk Management is about the Bad events
 What happens to the


10th percentile of the output gap?
90th percentile of the price-level gap?
5
US GDP Growth Following an Housing Boom (10% quantile)
Inflation Following an Housing Boom (90% quantile)
The Questions
1. Should housing costs or price be included
in a price index used for monetary policy?
2. Should a central bank target housing
prices separately from inflation
(and real growth)?
3. Are housing prices relevant indicators for
monetary policy?
8
Preview of the Answers
1. Housing might be included in a price index as a
part of the cost of living
2. Central banks should not target housing prices.
3. Housing prices are relevant indicators.
Housing booms & busts lower growth & raise inflation.
9
Why Measure Housing Prices?
1. GDP: deflate nominal construction
2. GDP: compute real & nominal consumption
3. CPI/HICP: Measure change in cost of living
4. Monetary policy
10
Methods for Including Housing
 User Cost / Rental Equivalence



NIPA Approach
Requires imputation
Tendency for rents  when home prices 
 Money Outlays / Payments


Cash-flow approach
Homeowners are hedged
 Net Acquisitions

Analogous to treatment of consumer durables
11
Owner-Occupied Housing
 What is the role of land?

You live in a house on the land.
 Isn’t housing an investment?

A house is a place to live.
12
Owner-Occupied Housing
1. Deflate Residential Construction:
Acquisition Price of New Homes
2. Real & Nominal Consumption:
Imputed Service Flow
3. Cost of Living:
a.
b.
Short-term: Service Flow
Long-term: Cost of Life, include asset price
13
The Central Bank and Housing
 Choice depends on why we care about inflation

Long-term decision making is difficult

Argues for a cost of life
14
Some Examples
 Substitute Resale Prices for Rent
(assumes real interest rate is constant)
 Cost of Life Index
(asset price in net present value of lifetime services)
15
Putting Home Sale Prices in the Core PCE Price Index
5
4.5
4
2000 -2005: 3/4 percentage
points higher!
3.5
3
2.5
2
1.5
1
0.5
0
1991
1992
1993
1994
1995
1996
1997
1998
Core PCE Inflation
1999
2000
Core PCE w/ OFHEO
2001
2002
2003
2004
2005
Housing and the Cost of Life
 Changes in the
Cost of Expected Lifetime Consumption
(also called an Intertemporal Cost of Living Index)
 Depends on


Prices of consumption now:
Traditional Consumer Price Index
Prices of consumption later: Asset Prices
 Housing services are ¼ to ⅓ of consumption
17
Dynamic Factor Index: Intuition
 Individual product inflation
= common inflation + idiosyncratic inflation
it  t  xit
 Objective is to measure common inflation
Can also be interpreted as a “pure” price index
 Result
^
^
 t   wi ( L)
it
i
18
Example: U.S.
9 components of the U.S. CPI plus Housing, 1977-99
Inflation
Measure
Average
Annual Growth Rate
1995-1999
CPI
2.21
CPI ex food & energy
2.28
DFI (no assets)
2.34
DFI w/ housing
2.49
19
Example: U.S.
 Conclusion:



Long-run trend is different
Short-run movements are different
Would policy have been different?
20
Examples: 12 Country Comparison
 Quarterly data 1978 to 1999
 DFI including



Retail Prices
Housing Prices
Stock Prices
21
Source: Bryan, Cecchetti, and O’Sullivan “Asset Prices in the Measurement of Inflation,”
De Economist 149, no. 4, 2001, 405-431
Example: 12 Country Comparison
 Housing has significant weight in all countries
 Often bigger than weight on retail prices
23
What Should Policymakers Do?
 Goal is stabilize prices (and growth)
 Target what you care about,
NOT housing prices!
 Two possibilities:
1.
2.
Change the targeted index to one with housing.
Include housing in interest-rate reactions.
24
What Should Policymakers Do?
 Practical arguments suggest the second



Consumer prices are well understood
CB would have to produce the index it targets
Reaction is flexible
25
Conclusion
 Housing booms influence CB objectives

No choice but to consider them
 Treatment in a price index affects policy


short-run movements in inflation affected
long-run trends in inflation changed
26