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US government: 36% price increase is really deflation

May 18, 2005

There was great relief in financial markets today when today's CPI reading came in. While the overall monthly increase of 0.5% was somewhat higher then expected, that only reflected higher food and energy prices and they apparently don't count. The core index was unchanged after having risen 0.7% over the previous two months. But this reading highly underestimate price inflation.

A illustration of this was given in a San Francisco Chronicle article. In San Francisco house prices has risen some 36% over the last 2 years. But home buyers need not worry. Because the government says that the cost of living in a San Fransisco home has in fact fallen. That's right the U.S. government statisticians try to have us believe that it is really cheaper now to live in a San Francisco home than 2 years ago, even though you have to pay 36% more for it. The explanation for this curious phenonema is that the government calculate the cost of living in a home you own by looking at the cost of renting a home and since rents have fallen this means that the government will claim that it is cheaper to buy a home now.

The government tries to justify this absurdity by arguing that they do not wish to include the asset value of homes. But even leaving aside the question of why asset price inflation should not be considered inflation, it should be noted that houses are assets whose fundamental value reflect the consumption services they provide, unlike other assets like stocks or bonds whose fundamental value reflect the future cash flow they will provide for the holder. And that accordingly, any price increase will make the consumption service of living in a house much more expensive.

Trying to measure the cost of living in a house you own through the cost of renting the house is like trying to measure car prices by the cost of transport through a bus or taxi.

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