Second, for most households, their cost of housing is little changed by movements in the price of their house. According to the Census Bureau, 95 percent of homeowners remain in the same house from one year to the next. For a non-mover household, the mortgage payment, by far the largest housing expenditure, generally does not change from one year to the next. Only the mover household, which has to buy or renegotiate its mortgage, will experience a significant difference in housing costs.4
Third, the HPI does not properly measure the change in costs for renters, who make up one-third of U.S. households. If increases in house prices were perfectly passed through to rent prices, then house prices would accurately measure housing costs for renters. However, the two rarely move in perfect synchrony.
There exist market-based rent measures from private sources such as Reis and Zillow. However, these are not ideal for estimating rental costs in an analysis such as this one because they are not adjusted for quality. For example, consider a fast-growing MSA in which new apartment buildings are constantly springing up as old buildings are being demolished. In this area, rents, according to market-based measures, will increase rapidly, as more people move to newer, nicer buildings that charge higher rents. However, rent prices would have changed anyway from one year to the next due to demographic shifts, property laws, and other reasons not related to the quality of housing. Thus, these rents reflect that renters are paying for a different kind of housing — higher quality or newer housing — and do not necessarily measure the actual inflation of rent costs.
Lastly, even if properly measured, growth in housing costs should still vary more than inflation because of substitution effects. In general, the housing expenditure weight — the share of household income spent on housing—is about 20 percent and not sensitive to changes in prices. As prices rise, households respond by purchasing less or cheaper housing, keeping the housing expenditure weight constant. It works the other way too: If prices decrease, households tend to buy more or costlier housing, again keeping the expenditure weight and inflation steady. As a result, the cost of living stays relatively stable compared with the change in house prices.
Properly Measuring Housing Costs
Our preferred measure of housing costs is rents from the BEA, which combine rent prices observed directly in the Census Bureau American Community Survey and owner-imputed rents calculated from Bureau of Labor Statistics consumer expenditure data.5 To evaluate changes in rents over time, we construct an implicit rent deflator, which is analogous to the overall implicit price deflator.6 These rents data measure only the cost of housing—for both owners and renters—instead of the value of the housing stock, and they adjust for the quality of housing, so they more accurately reflect what residents actually pay for housing.
As Figure 3 shows, rent growth is more evenly distributed geographically than house price growth. Rents are growing particularly rapidly in some regions, such as the Gulf Coast, but for most of the country, rent growth has been modestly positive. In 351 of the 381 MSAs in the data, house prices grew by between 0 and 5 percent annually from 2011 to 2015.
The (lack of) regional variation in rent growth aligns closely with the variation in inflation rates. Whereas there is little to no correlation between house price growth and inflation, there is a strong correlation between rent growth and inflation. As shown in Figure 4, about half of the variation of growth in the implicit price deflator across MSAs can be explained by growth in the implicit rent deflator, consistent with our expectation that housing costs will drive inflation.7
Conclusion
House price growth has varied significantly nationwide since the end of the Great Recession in 2009: In some MSAs, prices have grown as quickly as 7 percent annually, while others have seen prices decline almost as quickly, with many more MSAs falling somewhere in between. Since households spend more on housing than any other good or service, we would expect that inflation rates would show the same variation. They do not.
To analyze changes in the actual cost of living, one must look at measures more sophisticated than house prices, such as rents data from the BEA, which combine actual rents paid with estimates of owner-equivalent rents. Using these data, we show that changes in the cost of living do vary regionally, but considerably less than house prices. There still exists more variation in rents than in inflation, due in part to the fact that households will adjust how much housing they purchase when the price changes. Overall, though, these rents data accurately capture changes in how much households pay for housing, which explain a significant portion of regional inflation rates.
Notes
© 2018, Federal Reserve Bank of St. Louis. Views expressed do not necessarily reflect official positions of the Federal Reserve System.
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