Do Central Bankers Care About Rising House Prices?

Episode Summary

Executive Summary: The episode explains why CPI measures housing through rental equivalence rather than home purchase prices: inflation is intended to track the cost of current consumption, while homes also function as investments. It compares alternative housing measures, discusses central banks’ attention to asset prices and New Zealand’s mandate change, and shows how CPI can diverge from individuals’ lived inflation because of differences in location, age, income, and spending.

Main Topics: Why home prices are generally excluded from CPI: CPI aims to measure changes in the cost of goods and services consumed today. A home is both a source of housing services and an investment, so purchase prices are treated differently from consumption costs; maintenance is included. Rental equivalence as the standard housing measure: The U.S. and U.K. use estimated rent for owner-occupied homes to represent the consumption value of shelter. This captures the cost of living in a home while excluding asset-value changes not reflected in rents. Alternative methods produce different inflation readings: The episode contrasts rental equivalence with the ECB’s net acquisitions approach and methods based on mortgage payments or out-of-pocket costs. Each captures different elements of housing costs and can produce materially different results. Central banks and asset-price booms: Excluding house and stock prices from CPI does not mean central banks ignore them. Asset-price movements matter to policy when they affect the inflation outlook or threaten financial stability, but central banks are not tasked with setting fair asset values. New Zealand’s housing mandate and policy constraints: New Zealand instructed its central bank to consider housing prices in monetary policy. The bank attributed high prices partly to structural factors and low interest rates, while the episode notes that raising rates to restrain housing can harm employment and living standards. Inflation differs across households: CPI reflects a defined urban-consumer spending basket, not every person’s circumstances. Healthcare, education, fuel costs, and pandemic-era moves from cities can make individual inflation diverge from the official average.

Key Arguments: Home purchase prices combine the value of housing services with an investment component; CPI focuses on consumption, so rental equivalence is intended to isolate the cost of shelter services. A rise in home values that substantially exceeds rent growth may represent asset appreciation or expectations of future rent increases rather than a current increase in the cost of living. Housing is still a major part of measured inflation: shelter costs are about one-third of U.S. CPI, even though home sale prices themselves are not directly used. Different housing-cost methods can give sharply different inflation results. In the U.S. comparison cited, rental equivalence rose more than monthly principal-and-interest payments from 1983 to 2007. Central banks monitor housing and other asset prices, but the episode argues these should affect monetary policy insofar as they influence inflation forecasts or financial stability, rather than simply because asset prices rise. Adding housing prices to central-bank mandates does not provide an easy solution: low interest rates support housing valuations, while rate increases intended to cool prices can weaken employment and living standards. Official CPI can understate or overstate a household’s experienced inflation because spending patterns differ by age, income, location, and other circumstances; pandemic-related migration may also make urban rent measures less representative.

Data Points: U.S. household spending on shelter: Almost 40% of take-home pay - The host cites the Bureau of Labor Statistics when describing housing’s significance to household budgets. Population represented by U.S. CPI: About 90% - CPI is designed to represent inflation experienced by urban consumers, not every population group. U.S. CPI shelter weighting: Around one-third - Shelter costs, measured primarily through rental equivalence, are a major component of CPI. Homeownership: 65% of Americans; 63% of British people - The figures are used to question how intuitive rent-based housing measurement is for owner-occupiers. Countries using rental equivalence: 13 out of 30 OECD nations - The episode describes rental equivalence as the most common international method for measuring shelter-cost changes. U.S. CPI housing measure history: Home prices were included until 1983 - The CPI method changed to focus on the consumption component of housing. U.S. housing-cost comparison: 79% versus 140% from 1983 to 2007 - Monthly principal-and-interest payments needed to buy a home rose 79%, compared with a 140% increase in rental equivalence, according to the National Association of Realtors as cited in the episode. New Zealand interest rates: Around 10% in 1995 and around 0.25% at the time discussed - The host notes that falling rates increase buyers’ capacity to pay for housing and can push up house prices. New Zealand housing-policy instruction: Issued six months before the episode - The government formally instructed its central bank to consider housing prices in monetary-policy decisions.

Pivotal Quotes: "The actual cost of living in the house has not changed, but the cost of a real estate investment has." — Patrick Boyle: Explains why house-price increases above rent growth are treated as asset gains rather than current consumer-price inflation. "It's not the role of a central bank to decide the fair value of a house or of a share of Tesla." — Patrick Boyle, summarizing Ben Bernanke’s argument: Clarifies the distinction between monitoring asset prices and targeting their valuations. "In order for that to be sustainable, he said that we can't have a boom-and-bust cycle in something like real estate." — Patrick Boyle, quoting Eric Rosengren: Connects the Federal Reserve’s inflation goal with concern about destabilizing housing-market cycles.

Implications: CPI is a useful average, not a personal cost-of-living score. Housing policy debates should distinguish shelter consumption from investment values and recognize that different measurement methods change reported inflation. Central banks can monitor housing risks, but rate policy alone cannot resolve affordability without trade-offs.