Discussion of CNV and MP Discussion of CNV and MP on the CPI for Shelteron the CPI for Shelter

Robert J. GordonRobert J. GordonNorthwestern University and NBERNorthwestern University and NBER

Brookings Workshop on Brookings Workshop on Economic Measurement,Economic Measurement,

May 23, 2003May 23, 2003

TributesTributes

Congrats to the organizers for finding the Congrats to the organizers for finding the right papers on the most important right papers on the most important component in the CPIcomponent in the CPI

Congrats to the authors for adding Congrats to the authors for adding enormously to the body of knowledgeenormously to the body of knowledge About pitfalls in the CPI as they change over About pitfalls in the CPI as they change over

timetime Using new data sets, esp. the AHS, to provide Using new data sets, esp. the AHS, to provide

new perspective on potential sources of biasnew perspective on potential sources of bias This topic is the This topic is the BIG BANANA BIG BANANA of CPI biasof CPI bias

Apostle of Upward CPI Bias?Apostle of Upward CPI Bias? 1990 1990 The Measurement of Durable Goods PricesThe Measurement of Durable Goods Prices

I still love my monthly I still love my monthly Consumer ReportsConsumer Reports and sure miss and sure miss the Sears Cataloguethe Sears Catalogue

1996 Boskin Commission Report1996 Boskin Commission Report BUTBUT

Relative prices change all the timeRelative prices change all the time Now: many goods prices falling, but college tuition and Now: many goods prices falling, but college tuition and

plumbers’ fees keep risingplumbers’ fees keep rising Just wait for the decline of the dollar to start boosting a Just wait for the decline of the dollar to start boosting a

wide variety of imported goods priceswide variety of imported goods prices IN SAME WAYIN SAME WAY

Bias can differ greatly across products, sometimes up, Bias can differ greatly across products, sometimes up, sometimes down, relative extent of bias changing over sometimes down, relative extent of bias changing over timetime

Bias may change over timeBias may change over time Hulten-Bruegel paradoxHulten-Bruegel paradox Nordhaus’ suggestionNordhaus’ suggestion Hulten’s responseHulten’s response Extend back to BruegelExtend back to Bruegel

¼ lb of potatoes vs. those prosperous-looking Dutchmen¼ lb of potatoes vs. those prosperous-looking Dutchmen Resolution? Resolution?

Bias in durable goods (and Nordhaus for light) can’t be Bias in durable goods (and Nordhaus for light) can’t be applied to necessities (food, apparel, shelter)applied to necessities (food, apparel, shelter)

OR, OR, bias in necessities changed over timebias in necessities changed over time Boskin Report:Boskin Report: only 95-96, bias could have been only 95-96, bias could have been

higher or lower (or opposite sign?) at any point in higher or lower (or opposite sign?) at any point in the pastthe past

Prima Facie Prima Facie Case that the CPI for Case that the CPI for Shelter is Biased DownwardsShelter is Biased Downwards

Change over long historical periodsChange over long historical periods CPI for Shelter 1999/1925 = 5.1CPI for Shelter 1999/1925 = 5.1 To get that number, see CNV Appendix 2, where on To get that number, see CNV Appendix 2, where on

their base year, CPI (1925) = 34.5 (1940/1925!!)their base year, CPI (1925) = 34.5 (1940/1925!!) Median Price of Existing HousesMedian Price of Existing Houses

Historical StatisticsHistorical Statistics, Washington DC, 1925, $7,809, Washington DC, 1925, $7,809 Statistical Abstract, Statistical Abstract, Washington DC, 1999, Washington DC, 1999,

$176,000$176,000 Ratio = 22.5, not 5.1Ratio = 22.5, not 5.1

OK, OK, rent vs. ownership price including landrent vs. ownership price including land But CPI for shelter is used to proxy for home But CPI for shelter is used to proxy for home

ownership priceownership price Tenants pay for the land, not just the structureTenants pay for the land, not just the structure

Another ExampleAnother Example Historical Statistics, Historical Statistics, 19221922

Residential Wealth $71.3 billionResidential Wealth $71.3 billion Structures $51.1 billionStructures $51.1 billion Land $20.2 billionLand $20.2 billion

Number of housing units 19.5 million (why so Number of housing units 19.5 million (why so few?)few?)

Value per Unit = $3,656Value per Unit = $3,656 Statistical AbstractStatistical Abstract for 1999 for 1999

Net Residential Capital Stock $9,405 billionNet Residential Capital Stock $9,405 billion Number of units 115 millionNumber of units 115 million Value per Unit = $81,800Value per Unit = $81,800

Ratio 1999/1925 = 22.1 not 5.1Ratio 1999/1925 = 22.1 not 5.1 Could it Could it ALLALL be quality change? be quality change?

If the CPI-Shelter is Biased If the CPI-Shelter is Biased Downwards, Over What Interval?Downwards, Over What Interval?

CNV makes a convincing case that bias less in CNV makes a convincing case that bias less in 90s than before (MP limited to 89-01 interval)90s than before (MP limited to 89-01 interval)

Ingredients in Change over Time: CNV Key Ingredients in Change over Time: CNV Key Point that Rent Increases Occur with Tenant Point that Rent Increases Occur with Tenant TurnoverTurnover 1942: obtain rent from tenants rather than 1942: obtain rent from tenants rather than

landlords (WWII rent controls)landlords (WWII rent controls) Mail survey 1942-63: nonresponse rateMail survey 1942-63: nonresponse rate Telephone survey still misses tenant turnoverTelephone survey still misses tenant turnover 1978: interview landlord or tenant every 6 months1978: interview landlord or tenant every 6 months 1988: aging bias correction1988: aging bias correction 1994: recall bias correction1994: recall bias correction

Shocking Sources of Downward Shocking Sources of Downward CPI Bias in the PastCPI Bias in the Past

The “Case of the Disappearing Tenant”The “Case of the Disappearing Tenant” Why Emphasis on 6 month changes?Why Emphasis on 6 month changes? Why Not Structure Data Collection Around 12 Why Not Structure Data Collection Around 12

month change?month change? I am a landlord: I am a landlord: I know the history of both price I know the history of both price

and quality changeand quality change Parallel to Apparel Shocker: “The Case of Parallel to Apparel Shocker: “The Case of

the Dress that Goes on Sale”the Dress that Goes on Sale” Ride the Sale Price DownRide the Sale Price Down Link Out the New Dress at the Regular PriceLink Out the New Dress at the Regular Price

Apparel + Housing Resolve the Hulten-Apparel + Housing Resolve the Hulten-Bruegel Paradox (But don’t overturn Boskin)Bruegel Paradox (But don’t overturn Boskin)

Implications of CPI BiasImplications of CPI Bias CNV (and Weston) create presumption that bias CNV (and Weston) create presumption that bias

was greater 1942-78was greater 1942-78 Growth in real consumption and real GDP Growth in real consumption and real GDP

overstatedoverstated Golden age of productivity growth 1940-70 Golden age of productivity growth 1940-70

overstatedoverstated Less of a productivity growth slowdown after 1970Less of a productivity growth slowdown after 1970 Low Bias in 1990s implies bigger productivity revival Low Bias in 1990s implies bigger productivity revival

2% annual bias for 30% of the CPI implies 0.6% 2% annual bias for 30% of the CPI implies 0.6% annual upward bias for real consumption, 0.4% annual upward bias for real consumption, 0.4% for real GDPfor real GDP These are big numbers in the “battle of the basis points”These are big numbers in the “battle of the basis points”

CNV PaperCNV Paper

Real Addition to Our KnowledgeReal Addition to Our Knowledge Terrific History of CPI Methodology Terrific History of CPI Methodology

since 1942since 1942 Long-period Time HorizonLong-period Time Horizon Micro DataMicro Data

BLS Micro Data SetBLS Micro Data Set AHS Hedonic RegressionsAHS Hedonic Regressions

First, Let’s Correct those Little First, Let’s Correct those Little ErrorsErrors

Abstract says “CPI for rent over 1940-77 Abstract says “CPI for rent over 1940-77 may have been may have been overstatedoverstated by 1.5 percent by 1.5 percent annually”annually”

Appendix 2 says 1.8 percent not 1.5 percentAppendix 2 says 1.8 percent not 1.5 percent Overall Bias Result from Appendix 2Overall Bias Result from Appendix 2

1940-78 -1.801940-78 -1.80 1978-88 -1.161978-88 -1.16 1988-2002 -0.031988-2002 -0.03

Absence of bias after 1988 a stunning Absence of bias after 1988 a stunning result, just as is -1.80 before 1978result, just as is -1.80 before 1978

What Did I Think Beforehand?What Did I Think Beforehand?

1940-70 Weston’s Thesis1940-70 Weston’s Thesis 1970-99 Regressions from AHS Summary 1970-99 Regressions from AHS Summary

DataData Slightly Different Periods, but same Slightly Different Periods, but same

general pattern:general pattern: 1940-75 -3.491940-75 -3.49 1975-91 -1.341975-91 -1.34 1991-99 +1.791991-99 +1.79

Open Questions:Open Questions: Interpretation of Weston 1940-70Interpretation of Weston 1940-70 CNV More Reliable 1975-99CNV More Reliable 1975-99

My Little Corner of the WorldMy Little Corner of the World

Historical rent index for Evanston ILHistorical rent index for Evanston IL Many versions, hedonic, nonhedonic, identical Many versions, hedonic, nonhedonic, identical

addresses etc.addresses etc. Source: newspaper advertisements going back Source: newspaper advertisements going back

to 1925to 1925 Implications: CPI minus EvanstonImplications: CPI minus Evanston

1925-40 -0.94%1925-40 -0.94% 1940-80 -1.43%1940-80 -1.43% 1980-90 -0.02%1980-90 -0.02% 1990-99 +0.05%1990-99 +0.05%

Issue We Shouldn’t Take for Issue We Shouldn’t Take for Granted: Aging BiasGranted: Aging Bias

CNV Take This at Face ValueCNV Take This at Face Value Yes, Clearly a Source of Downward CPI Bias in the Yes, Clearly a Source of Downward CPI Bias in the

PastPast But What does it Mean?But What does it Mean?

Location: Inner-city vs. SuburbsLocation: Inner-city vs. Suburbs Omitted quality variables from my perspective as an Omitted quality variables from my perspective as an

Evanston landlord: Evanston landlord: New high-rises have viewsNew high-rises have views Central air conditioning, new kitchensCentral air conditioning, new kitchens

But do the older units actually decline in quality?But do the older units actually decline in quality? My coach house says “no”! Renovations not only by owner My coach house says “no”! Renovations not only by owner

but by tenants!but by tenants! Distinction between maintenance (roof, gutters) vs. Distinction between maintenance (roof, gutters) vs.

improvements (e.g., circuit board, kitchen appliances, new and improvements (e.g., circuit board, kitchen appliances, new and better floors)better floors)

Where Do the CNV Estimates Where Do the CNV Estimates Come From?Come From?

Model, Apply corrections for new Model, Apply corrections for new renters, recall bias, vacancy renters, recall bias, vacancy imputation while using CPI estimates imputation while using CPI estimates of aging biasof aging bias

Credibility test for 1940-77Credibility test for 1940-77 Their model bias -1.8%Their model bias -1.8% Median gross rent 1940-77 -2.6%Median gross rent 1940-77 -2.6% Implies quality change ~+0.8%Implies quality change ~+0.8% This seems very plausibleThis seems very plausible

Closer Look at 1975-87Closer Look at 1975-87

Growth Rates from their Table 12Growth Rates from their Table 12 CPI minus Median Gross Rent -1.70%CPI minus Median Gross Rent -1.70% CPI minus their adjusted index -1.78%CPI minus their adjusted index -1.78% CPI minus their hedonic AHS index -2.00%CPI minus their hedonic AHS index -2.00%

Median Gross Rent vs. HedonicMedian Gross Rent vs. Hedonic Implies quality decline of -0.3% per yearImplies quality decline of -0.3% per year They don’t comment on thisThey don’t comment on this Is it credible?Is it credible? Could it be a location phenomenon – south, Could it be a location phenomenon – south,

suburbs?suburbs?

Puzzle of Repeat Rent MeasurePuzzle of Repeat Rent Measure Blank in Cell 1983-85 (Table 12)Blank in Cell 1983-85 (Table 12) Average for 1975-87 omitting 83-85Average for 1975-87 omitting 83-85

CPI minus AHS Median Gross Rent -1.74CPI minus AHS Median Gross Rent -1.74 CPI minus their model -1.92CPI minus their model -1.92 CPI minus hedonic AHS -1.86CPI minus hedonic AHS -1.86 CPI minus AHS Repeated Rent -0.20CPI minus AHS Repeated Rent -0.20

Why? They don’t know (p. 28)Why? They don’t know (p. 28) This is where the MP paper should help, but it This is where the MP paper should help, but it

doesn’tdoesn’t Implied quality improvement missed by hedonic index is Implied quality improvement missed by hedonic index is

not crediblenot credible Is the CNV Repeated Rent Index Identical in Is the CNV Repeated Rent Index Identical in

Principle to the MP index? (Homework Principle to the MP index? (Homework Assignment)Assignment)

So MP Step In Regarding AHSSo MP Step In Regarding AHS

Interesting Hypothesis: Bias by Interesting Hypothesis: Bias by Insufficient Sampling of Top Part of Insufficient Sampling of Top Part of MarketMarket

Recall Paul Pieper on Residential Recall Paul Pieper on Residential Housing: Omission of 2000+ sq. ft. Housing: Omission of 2000+ sq. ft. houses biases down housing inflation by houses biases down housing inflation by ~1% per year~1% per year

Is it something special about top of the Is it something special about top of the market or unmeasured quality attributes? market or unmeasured quality attributes?

MP Paper DisappointingMP Paper Disappointing Sample Period only 1989-2001Sample Period only 1989-2001

They Miss the Big Period of CPI Bias pre-1989They Miss the Big Period of CPI Bias pre-1989 Why Don’t They Exploit the AHS 1975-89?Why Don’t They Exploit the AHS 1975-89?

Why Don’t They Cumulate Their Own Why Don’t They Cumulate Their Own Results and Convert to Annual Rates?Results and Convert to Annual Rates? Charts 4 and 5. Charts 4 and 5.

Tenant Rent CPI minus their AHS index +0.37Tenant Rent CPI minus their AHS index +0.37 OER CPI minus their AHS index +0.77OER CPI minus their AHS index +0.77 Significant Conflict with CNV paperSignificant Conflict with CNV paper

Their short-run orientation is unconvincing and, Their short-run orientation is unconvincing and, in this crowd, uninteresting. We care about in this crowd, uninteresting. We care about decades, not two-year intervalsdecades, not two-year intervals

NitpicksNitpicks

P. 4: “[the pre-1983 CPI treatment of P. 4: “[the pre-1983 CPI treatment of housing was] analogous to the CPI’s housing was] analogous to the CPI’s current treatment of automobiles current treatment of automobiles and other consumer durables.and other consumer durables. NO! The current CPI is MUCH better NO! The current CPI is MUCH better

than that!than that! Poor explanation of what was wrong Poor explanation of what was wrong

with CPI pre-1983.with CPI pre-1983. Wrong weights, applying the current Wrong weights, applying the current

mortgage rate to all outstanding mortgagesmortgage rate to all outstanding mortgages

Big Issue of Principle: OER CostsBig Issue of Principle: OER Costs

MP (p. 10) includes MP (p. 10) includes ““Cost of Capital” equals value of the Cost of Capital” equals value of the

property net of 8 percent transaction property net of 8 percent transaction costscosts

Times “The yearly average of the 30-year Times “The yearly average of the 30-year fixed mortgage rate minus ½ percentag fixed mortgage rate minus ½ percentag point”point”

Add “real estate taxes, utilities, insurance Add “real estate taxes, utilities, insurance costs”costs”

Add depreciation = 1% of property valueAdd depreciation = 1% of property value

What if Mortgage Interest Declines What if Mortgage Interest Declines from 7.0 to 5.2 over Two Years?from 7.0 to 5.2 over Two Years?

Property Value net of 8% = $200,000Property Value net of 8% = $200,000 Mortgage Component falls from Mortgage Component falls from

$14,000 to $10,400$14,000 to $10,400 Say Taxes, utilities, etc. = $7,000, Say Taxes, utilities, etc. = $7,000,

increasing at 4% per yearincreasing at 4% per year Depreciation = $2,000Depreciation = $2,000 Total OER cost declines from $23,000 Total OER cost declines from $23,000

to $19,970to $19,970 Annualized inflation = -7.06%Annualized inflation = -7.06%

Why We Don’t Want Mortgage Why We Don’t Want Mortgage Rates in the CPIRates in the CPI

Didn’t We Settle This in 1983?Didn’t We Settle This in 1983? These Fed Economists are Monetary These Fed Economists are Monetary

Policy ImperialistsPolicy Imperialists The Fed Controls the CPI!The Fed Controls the CPI! This Nonsense Plagued the British CPI This Nonsense Plagued the British CPI

for years!for years! Low Interest Rates Create Capital Low Interest Rates Create Capital

Gains, and we don’t want Capital Gains, and we don’t want Capital Gains in CPI or GDP Gains in CPI or GDP

Dramatic Example of Why We Dramatic Example of Why We Don’t Capture OER Inflation with Don’t Capture OER Inflation with

CPI for RentsCPI for Rents My friend:My friend:

Condo worth $225KCondo worth $225K Annual Rental $19,800Annual Rental $19,800

Apply this to a $1 million house, of which Apply this to a $1 million house, of which there are a LOT there are a LOT Implies monthly rent = $7,333Implies monthly rent = $7,333

Where is the rental market for $7,333 per Where is the rental market for $7,333 per month houses? It doesn’t exist for good month houses? It doesn’t exist for good reasons that home ownership makes big reasons that home ownership makes big houses very cheaphouses very cheap

Two Alternatives for OERTwo Alternatives for OER

Option #1Option #1 Take seriously the role of capital gains in Take seriously the role of capital gains in

making homeownership cost virtually zero over making homeownership cost virtually zero over timetime

Let housing costs in CPI ride the roller-coaster of Let housing costs in CPI ride the roller-coaster of the current mortgage interest ratethe current mortgage interest rate

Option #2Option #2 Pretend that capital gains don’t existPretend that capital gains don’t exist Base CPI on rate of inflation in property taxes, Base CPI on rate of inflation in property taxes,

insurance, utilities, and home maintenanceinsurance, utilities, and home maintenance I want our CPI and GDP deflator to be based I want our CPI and GDP deflator to be based

on #2 not #1. How about You?on #2 not #1. How about You?