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Price Indices: Part 4

MEASUREMENT ECONOMICS

ECON 4700

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This part…

• Problems areas and issues for the CPI– The treatment of shelter– Plutocratic vs. Democratic weighting– The treatment of quality change

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Shelter in the CPI

– Problem• Investment or consumption?

– Shelter is an important expenditure• Shelter = 27%

• Owned accommodation = 16%

4

Shelter in the CPI

• Six various measures are presented based on four different concepts– Statistics Canada’s Official Concept

(user cost)– Rental equivalence– Money outlays (payments approach)– Net purchases (acquisitions approach)

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Shelter in the CPI

• Official concept– Definition: Measures the price induced

changes associated with the cost of owning and using a given stock of owner-occupied dwellings. Includes actual and imputed costs.

– Advantages: • Covers elements similar to those that a

landlord factors in when fixing rents.

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Shelter in the CPI

• Rental equivalence– Definition: Imputes changes of market

rents to the population of homeowners.– Advantages:

• Consistent with the national accounts.• Isolates the consumption flow of owner-

occupied housing from the savings flow.

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Shelter in the CPI

• Money outlays (payments approach)– Definition: Measures price induced changes associated with

the consumption related payments of owner-occupied housing.

– MO 1: Excluding equity payment– MO 2: Including equity payment – Advantages:

• Reflects actual costs to homeowners for their shelter. No imputation or notional amounts are involved.

• Most of the population would identify their own home ownership experiences with this concept.

• Escalator of money incomes

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Shelter in the CPI

• Net purchases (acquisitions approach)– Definition: Measures changes in market (transaction) prices

for owned accommodation (with or without mortgage interest charges).

– = purchases of new and existing owner-occupied dwellings minus sales of such dwellings

– “Net” purchases of existing dwellings is insignificant therefore net purchases = new purchases.

– NP 1: Based on purchases– NP 2: Based on down payments and discounted mortgage

payments (Alan Blinder, 1980)– Advantages:

• Preferred measure for monitoring inflation and for monetary policy.

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Shelter in the CPI

• No owned accommodation• Definition: Simply exclude

homeownership from the CPI. Housing is an purely a financial asset. – Advantages:

• Easy solution and compatible with the current HICP and other country practices.

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Shelter in the CPICommodity group OFFICIAL RE MONEY OUTLAYS NET PURCHASE

EXCLUDING EQUITY

PAYMENT

INCLUDING EQUITY

PAYMENT

PURCHASES DOWNPAYMENTS AND MORTGAGE PAYMENTS

Homeowners’ maintenance and repairs 9.6 6.0 11.9 9.8 11.8 11.6Condo charges 2.0 2.5 2.1 2.5 2.5Property taxes 20.9 26.0 21.4 25.6 25.2Insurance premiums 5.1 3.3 6.4 5.3 6.3 6.2Mortgage insurance 1.2 1.5 1.2Mortgage interest charges 36.7 45.6 37.7 1.4Replacement cost 19.5Real estate commissions 2.7 3.4 2.8 3.3 3.3Legal fees 0.9 1.1 0.9 1.1 1.1Other shelter services 1.4 1.7 1.4 1.7 1.6Equivalent rent 90.7Down payments (NP2) 15.2Home purchase (NP1) 47.8Discounted Mortgage payments 31.9Net equity = Down payment + principal share of payment - sale of house 17.4

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Shelter in the CPI

Commo-dity grouping

Official Rental

equiva-lence

Money outlays

Net purchase

No equity pmt

With equity pmt

PurchasesDown

pmt and mgt pmt

Shelter 58.6 66.2 53.2 58.0 53.6 54.0

All-items

15.3 19.9 12.6 14.9 12.8 13.0

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Price Index Series for Owned Accommodation (January 2000 = 100)Price Index Series for Owned Accommodation (January 2000 = 100)

95.00

100.00

105.00

110.00

115.00

120.00

125.00

130.00

Jan-00Apr-00Jul-00Oct-00Jan-01Apr-01Jul-01Oct-01Jan-02Apr-02Jul-02Oct-02Jan-03Apr-03Jul-03Oct-03Jan-04Apr-04Jul-04Oct-04Jan-05Apr-05Jul-05Oct-05Jan-06Apr-06

month

index

INDXOFFINDXREINDXMO1INDXMO2INDXNP1INDXNP2

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Price Index Series for All items using NHPI (January 2000 = 100)

95.00

97.00

99.00

101.00

103.00

105.00

107.00

109.00

111.00

113.00

115.00

Jan-00Apr-00Jul-00Oct-00Jan-01Apr-01Jul-01Oct-01Jan-02Apr-02Jul-02Oct-02Jan-03Apr-03Jul-03Oct-03Jan-04Apr-04Jul-04Oct-04Jan-05Apr-05Jul-05Oct-05Jan-06Apr-06

month

index

IndOff_allInd_all_ReInd_all_MO1Ind_all_MO2Ind_all_NP1Ind_all_NP2

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ShelterOwned

accommodationShelter All-items

Official 2.24 2.89 1.91

Rental equivalence 1.43 1.82 1.79

Money outlays (1) 1.77 2.0 1.84

Money outlays (2) 1.03 1.58 1.73

Net purchase (1) 3.30 2.92 2.08

Net purchase (2) 2.31 2.34 1.93

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• The NHPI

HEDONIC INDEX COMPARISON

95

100

105

110

115

120

Jan-04Mar-04May-04Jul-04Sep-04Nov-04Jan-05Mar-05May-05Jul-05Sep-05Nov-05Jan-06Mar-06

DATE

INDEXES

POOLED SIMPLE VARIABLESIMPLE VARIABLE PERIOD ADJACENTHEDONIC REPLACEMENTNHPI

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Democratic vs. Plutocratic

• Democratic: An index in which each household index is given equal weight

• Plutocratic: A price index in which all dollars of expenditure are treated equally, so that, implicitly, each household is weighted proportional to its expenditures.

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Democratic vs. Plutocratic

PLt =

qn0pn

t

N=1

N

Â

qn0pn

0

N=1

N

Â=

q0pt

q0p0

r nt =

pnt

pn0

PLt =

qn0pn

0r nt

N=1

N

Â

qn0pn

0

N=1

N

Â=

qn0pn

0

x0n=1

N

 r nt = sn

0

n=1

N

 r nt

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Democratic vs. Plutocratic

r nt =

pnt

pn0

PPt =

qntpn

t

N=1

N

Â

qntpn

0

N=1

N

Â=

qtpt

qtp0

Ppt( )

- 1=

qntpn

t r nt( )

- 1

N=1

N

Â

qntpn

t

N=1

N

Â=

qntpn

t

xtn=1

N

 r nt( )

- 1= sn

t

n=1

N

 r nt( )

- 1

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Democratic vs. Plutocratic

Pft = pL

t pPt( )

1 2

PWt =

qntqn

0( )1 2

pnt

N=1

N

Â

qntqn

0( )1 2

pn0

N=1

N

Â

- 1

PM- Et =

qnt + qn

0( )

2pnt

N=1

N

Âqnt + qn

0( )

2pn

0

N=1

N

Â

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Democratic vs. Plutocratic

PLt h =

qn0hpn

0

x0hn=1

N

 r nt = sn

0h

n=1

N

 r nt

PLt A =

Qn0pn

0

X0n=1

N

 r nt = Sn

0

n=1

N

 r nt

Sn

0 =Qn

0pn0

X0=

qn0hpn

0

h

N

ÂX0

=x0h

X0

qn0hpn

0

x0hh

N

 =x0h

X0sn

0

h

N

Â

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Democratic vs. Plutocratic

PLt A =

x0h

X0PLt h

h

N

Â

PLt D =

1H

PLt h

h

N

Â

PLt D =

1H

sn0hr n

t

n=1

N

ÂHÂ = sn

0r nt

n=1

N

Â

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Democratic vs. Plutocratic

• The last equation tells us that you a democratic Laspeyres price index can be estimated if we can calculate, in addition to the price relatives, the population average of the household budget shares.

• The merits of the democratic index which gives every household an equal weight in the CPI are ideal for welfare analysis and income indexation.

• If you want every dollar to count the same (e.g., deflation in national accounts), then you are better off with a plutocratic index.