What Inflation?

Nick Halaris
Jan 3, 2018 · 4 min read

While the Fed seems continually vexed by the apparent absence of inflation, from the point of view of real estate markets (and most people in America) it is an undeniable reality. In fact, inflation has been raging for years now in the “price of housing” and wreaking havoc on standards of living everywhere.

Getting down to basics — that is, what people actually must pay to rent an apartment unit or house — inflation has been growing pretty much out of control for a decade:

And in urban centers — the places where people really want to live — it is definitely out of control:

The data from the “for-sale” market isn’t any more encouraging:

For ordinary Americans, inflation in the price of housing is such old news, so status quo, that it isn’t something people talk about anymore. A similar and equally dangerous trend is happening in health care:

Meanwhile, the Fed is stubbornly holding the line on the “there is no inflation in America” narrative.

There are many problems with “official” economic statistics, but perhaps none worse than the treatment of the price of housing in calculating inflation. Rather than just looking at real market prices for rent, the BLS uses the strange concept of “owners equivalent rent.” The entire number is based on a survey of consumers that relies on two ridiculous questions:

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

2. For renters: “What is the rental charge to your [household] for this unit including any extra charges for garage and parking facilities? Do not include direct payments by local, state or federal agencies. What period of time does this cover?”

The question for renters is straightforward enough, but the question posed to homeowners is, well, very questionable. Do we really think typical homeowners have a good sense of the market rental price of their homes?

It gets even crazier as we read further into the BLS’s explanation (see here if interested). To illustrate the problem, here is a “simple” formula for calculating the monthly change (taken directly from the BLS):

In an age of data science and machine learning, does it have to be this complicated? Clearly, the owner’s equivalent rent measure vastly underestimates inflation, especially when considering the fact that rent consumes almost 50% of the average household income in many markets:

Jim Grant of Grant’s Interest Rate Observer reminds us that there are two kinds of deflation:

  1. Bad Deflation — when prices fall everywhere because of lack of demand.


2. Good Deflation — when specific prices fall because of innovation.

The unofficial narrative is that there has been enough so-called Good Deflation in other areas of economic life to offset the inflation in necessities such as shelter and health care. But surely that cannot be true. If you are paying 50% of your income on rent and another 10% on healthcare, what difference does it make if the price of a Netflix subscription goes down, or if you pay a little less for your cell phone? No, despite their positive contributions, tech companies and VC’s aren’t saving the world from inflation.

Obviously, the rising price to rent or buy a home hurts household purchasing power; even so, with the costs of housing inflation, urban centers in America are thriving. The question implied by the real estate markets is this: Are there two kinds of inflation? What people should be asking is if there is any good in the price of housing inflation?

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