Discussion of Poole-Placek-Discussion of Poole-Placek-Verbrugge on Verbrugge on

Owner-Occupied Housing Owner-Occupied Housing in the CPIin the CPI

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

Federal Economic Statistics Advisory Committee Federal Economic Statistics Advisory Committee (FESAC)(FESAC)

December 9, 2005December 9, 2005

Wide-Ranging Contribution Wide-Ranging Contribution on an Important Topicon an Important Topic

30% of CPI is based on rental-equivalence 30% of CPI is based on rental-equivalence indexesindexes

Upside-down pyramidUpside-down pyramid 23% of CPI is owner-occupied housing based 23% of CPI is owner-occupied housing based

on indexes that cover 7% of renter-occupied on indexes that cover 7% of renter-occupied housinghousing

The paper rightly asks, is it proper to The paper rightly asks, is it proper to proxy the biggest component of the CPI by proxy the biggest component of the CPI by something that might be behaving very something that might be behaving very differently?differently?

BackgroundBackground Authors (pp. 40-42) coin a new acronym Authors (pp. 40-42) coin a new acronym

“GvG” for my recent paper, the first time “GvG” for my recent paper, the first time I’ve ever been called a palindromeI’ve ever been called a palindrome

I’ll reciprocate by calling them PPVI’ll reciprocate by calling them PPV You called in the right guyYou called in the right guy

Home-owner since 1968. Turned a $15K down Home-owner since 1968. Turned a $15K down payment into multi-millions of home equity, payment into multi-millions of home equity, negative user cost (didn’t every professor my negative user cost (didn’t every professor my age do that, nothing special?)age do that, nothing special?)

Landlord since 1996. I understand why rents Landlord since 1996. I understand why rents are persistent, change with tenant turnover, are persistent, change with tenant turnover, and how utilities and maintenance work (6 and how utilities and maintenance work (6 tenants in 9 yrs)tenants in 9 yrs)

Other Background Other Background (for the young folks)(for the young folks)

Chapter on deflation of structures in my 1967 Chapter on deflation of structures in my 1967 PhD thesis, published in REStat in 1968PhD thesis, published in REStat in 1968

Hired by the BEA (then OBE) to do a private Hired by the BEA (then OBE) to do a private consultant report on structures deflation in consultant report on structures deflation in 19691969

Wrote an article in the Wrote an article in the Public InterestPublic Interest in 1981 in 1981 about the absurd CPI treatment of housingabout the absurd CPI treatment of housing

Wrote the GvG paper (with Todd van Wrote the GvG paper (with Todd van Goethem) on a century of quality change and Goethem) on a century of quality change and CPI bias in rental housingCPI bias in rental housing

This Paper has FourThis Paper has Four Sections, Only Partly Connected Sections, Only Partly Connected

Conceptual Comparison of User Cost Conceptual Comparison of User Cost (UC) with Rental Equivalence (RE)(UC) with Rental Equivalence (RE)

Methodological Hitory of Shelter Cost Methodological Hitory of Shelter Cost in CPIin CPI

Current Sample Design and Methods in Current Sample Design and Methods in the CPI Housing Surveythe CPI Housing Survey

Survey of “homeowner cost inflation Survey of “homeowner cost inflation measures”measures”

3 follows from 2, but 1 and 4 are 3 follows from 2, but 1 and 4 are separateseparate

A quick reaction to each section,A quick reaction to each section,then more extended commentsthen more extended comments

#1, user cost (UC) vs. rental equiv (RE)#1, user cost (UC) vs. rental equiv (RE) I agree completely that UC is too volatile, I agree completely that UC is too volatile,

too hard to measure, and if implemented too hard to measure, and if implemented would make the CPI uselesswould make the CPI useless Hard to measure? Doesn’t even mention AMT!Hard to measure? Doesn’t even mention AMT!

I recommend the second paper sent to us I recommend the second paper sent to us as background by Verbruggeas background by Verbrugge He can’t find any connection between RE and UCHe can’t find any connection between RE and UC He concludes this makes RE hopeless as a proxy He concludes this makes RE hopeless as a proxy

for UC, while I would conclude the opposite (that for UC, while I would conclude the opposite (that UC is hopeless as a proxy for RE)UC is hopeless as a proxy for RE)

Sections #2 and #3Sections #2 and #3on the history of methdologyon the history of methdology

Section #2 doesn’t come down hard Section #2 doesn’t come down hard enough on the pre-1983 CPI enough on the pre-1983 CPI treatment of housing and its treatment of housing and its absurdities. Makes it sound like an absurdities. Makes it sound like an implementation of UC.implementation of UC.

Section #3 is full of too many details Section #3 is full of too many details without explaining to us which if any without explaining to us which if any of these details actually matter in of these details actually matter in creating a divergence between creating a divergence between growth rates of the ultimate indexgrowth rates of the ultimate index

Section #4, the Section #4, the survey of other worksurvey of other work

I’m involved here – the GvG paper is dismissed I’m involved here – the GvG paper is dismissed as showing no bias in the CPI as showing no bias in the CPI AFTER 1995!AFTER 1995!

The whole point of our paper was to investigate The whole point of our paper was to investigate CPI bias for the entire 20CPI bias for the entire 20thth century! century!

One of our basic conclusions is that the CPI One of our basic conclusions is that the CPI improved greatly after the 1980simproved greatly after the 1980s

Nary a comment about this broader context in Nary a comment about this broader context in PPVPPV

P. S. you left us out of your reference listP. S. you left us out of your reference list

Big Issues in UC vs. REBig Issues in UC vs. RE UC: low interest rates have a negative UC: low interest rates have a negative

correlation with housing price inflationcorrelation with housing price inflation This makes UC highly volatile esp. recentlyThis makes UC highly volatile esp. recently UC inappropriate for BEA price deflators because UC inappropriate for BEA price deflators because

they are driven by capital gains, but you can’t they are driven by capital gains, but you can’t calculate UC without a capital gains termcalculate UC without a capital gains term But capital gains are excluded from all components of But capital gains are excluded from all components of

GDP and the deflators!GDP and the deflators! Is my cost of living negative when my stock portfolio Is my cost of living negative when my stock portfolio

doubles? Where’s the logical case for including housing doubles? Where’s the logical case for including housing CG but not stock market CG??CG but not stock market CG??

This creates a This creates a prima facieprima facie case that UC measures case that UC measures can’t be used in official price deflatorscan’t be used in official price deflators

Thank you for CritiqueThank you for Critiqueof OFHEO Repeated Sales Indexesof OFHEO Repeated Sales Indexes

This was new to meThis was new to me Who knew that 80% of OFHEO repeated Who knew that 80% of OFHEO repeated

sale index was based on refinancing!sale index was based on refinancing! Any accusation against appraisers for Any accusation against appraisers for

“over-appraising” is a level effect, not a “over-appraising” is a level effect, not a growth rate effectgrowth rate effect

The big weakness of repeated sales The big weakness of repeated sales indexes is quality change (my house!)indexes is quality change (my house!)

A technical issue about A technical issue about maintenance and depreciatonmaintenance and depreciaton

That “gamma” term in the user cost formula That “gamma” term in the user cost formula “collects the rates of depreciation, maintenance, “collects the rates of depreciation, maintenance, and property taxes.”and property taxes.”

What?What? Maintenance can’t be Maintenance can’t be addedadded to depreciation. to depreciation. Maintenance is the Maintenance is the offsetoffset to deprecation to deprecation

Maintenance is the neglected aunt in the closet – it Maintenance is the neglected aunt in the closet – it is the offset to the aging bias in the CPI hedonic is the offset to the aging bias in the CPI hedonic regressionsregressions

Subjective: saving the 1889 relic with 10000 sfSubjective: saving the 1889 relic with 10000 sf Would anyone in this room deny that most 1889 properties Would anyone in this room deny that most 1889 properties

are now higher quality than in 1889??are now higher quality than in 1889?? All 1889 properties which are not higher quality have been All 1889 properties which are not higher quality have been

torn downtorn down

UC confuses real incomeUC confuses real income and real wealth and real wealth

Go back to BEA schizophrenia, I rent my house Go back to BEA schizophrenia, I rent my house from myselffrom myself Me as owner makes capital gains, I become Me as owner makes capital gains, I become

wealthierwealthier Do I pass all these on to myself as renter?Do I pass all these on to myself as renter?

No! Why not. Because the rent charged by the No! Why not. Because the rent charged by the owner-occupier at the margin depends on the owner-occupier at the margin depends on the rent charged in the open market for similar rent charged in the open market for similar houseshouses

The owner side of the schizophrenic can pocket The owner side of the schizophrenic can pocket the capital gains without passing them on to his the capital gains without passing them on to his renter half if competitive conditions warrant it.renter half if competitive conditions warrant it.

The Landlord SpeaksThe Landlord Speaks

Apartment rents are inherently inertialApartment rents are inherently inertial Why?Why?

Leases are typically for a year – no rental Leases are typically for a year – no rental change allowed, no allowance for changing change allowed, no allowance for changing energy costsenergy costs

There is assymetric info at the beginning, we There is assymetric info at the beginning, we don’t know who will be a good tenant. Once don’t know who will be a good tenant. Once we find one, we want to keep them, so low rent we find one, we want to keep them, so low rent increases for good tenantsincreases for good tenants

The concept of “good tenant” is not part of the The concept of “good tenant” is not part of the economics of housingeconomics of housing

Then What Happens?Then What Happens?

With bad tenants, you jump the rent, With bad tenants, you jump the rent, they leave, so it doesn’t matter for they leave, so it doesn’t matter for price indexesprice indexes

Once they say they won’t renew lease, Once they say they won’t renew lease, you then look at the marketplace and you then look at the marketplace and decide on the competitive price.decide on the competitive price.

Sometimes we don’t guess right, Sometimes we don’t guess right, nobody calls, and we actually reduce nobody calls, and we actually reduce the rent, this happened in August 2005the rent, this happened in August 2005

The Light Touch on pre-1983 CPIThe Light Touch on pre-1983 CPI

The PPV paper confuses the issue, The PPV paper confuses the issue, makes it sound like pre-1983 CPI was a makes it sound like pre-1983 CPI was a UC indexUC index

NoNo Multiple flawsMultiple flaws

Treated mortgage interest payments as a Treated mortgage interest payments as a nominal interest rate rather than a real interest nominal interest rate rather than a real interest raterate

Calculated mortgage interest expense as if Calculated mortgage interest expense as if everyone had to get a 1-yr ARM rather than what everyone had to get a 1-yr ARM rather than what they actually did, a 30-yr fixed rate. they actually did, a 30-yr fixed rate.

The Incredible Effects of The Incredible Effects of CPI Housing Treatment pre-1983CPI Housing Treatment pre-1983

PPV p. 19 display the effectsPPV p. 19 display the effects AAGR ending 9/81AAGR ending 9/81

Wrong: 11.0 Wrong: 11.0 for total CPIfor total CPI Right: 9.2 Right: 9.2 for total CPIfor total CPI

How many people lost their jobs as Paul How many people lost their jobs as Paul Volcker reacted to this CPI treatment?Volcker reacted to this CPI treatment?

Causation? Causation? CPI exaggerates inflationCPI exaggerates inflation Volcker fights inflation by raising interest ratesVolcker fights inflation by raising interest rates Everyone loses jobs, esp. the rust beltEveryone loses jobs, esp. the rust belt

Interpretation of 0.3 per yearInterpretation of 0.3 per yearAging BiasAging Bias

How have the national accounts integrated How have the national accounts integrated aging bias and maintenance.aging bias and maintenance.

Let’s imagine that a typical unit declines in Let’s imagine that a typical unit declines in value by 0.6% per year with no value by 0.6% per year with no maintenancemaintenance

But maintenance occurs at a rate of +0.3But maintenance occurs at a rate of +0.3 CPI comes along and estimates -0.3 aging CPI comes along and estimates -0.3 aging

effect. effect. Maintenance is behind the scenes.Maintenance is behind the scenes. We need integrated maintenance accountsWe need integrated maintenance accounts

Big Issue: Big Issue: Incongruity between Apt rent Incongruity between Apt rent

and house rentand house rent

What would my house rent for, a basic What would my house rent for, a basic question that the CPI must answerquestion that the CPI must answer

ProblemsProblems Every rental of a house in most parts of Every rental of a house in most parts of

the U. S. is an anomalythe U. S. is an anomaly Someone is on leave, someone is visitingSomeone is on leave, someone is visiting People move, they are in temporary digsPeople move, they are in temporary digs My current tenantMy current tenant

Owner Sample vs,. Rental sampleOwner Sample vs,. Rental sample

Nobody rents in mainly O-O areas Nobody rents in mainly O-O areas except for bizarre reasons that leaves except for bizarre reasons that leaves these price observations suspect, these price observations suspect, sample selection biassample selection bias

But this punts on the basic issue, is the But this punts on the basic issue, is the rate of change of rentsrate of change of rents any different? any different?

Does all this discussion of sampling Does all this discussion of sampling from the O-O population really matter?from the O-O population really matter?

Methodology: A New IssueMethodology: A New Issue

What to do about utilities subtracted from What to do about utilities subtracted from rentrent

Let energy prices accelerate, net rental Let energy prices accelerate, net rental indexes declineindexes decline

Superficially seems like a big problemSuperficially seems like a big problem But in a cosmic sense, let energy prices be But in a cosmic sense, let energy prices be

allocated in an accounting schemeallocated in an accounting scheme Rent goes down, make sure something else Rent goes down, make sure something else

goes up goes up pari passupari passu A problem for the CPI, but not in principle A problem for the CPI, but not in principle

for the BEAfor the BEA

Part 3 on SamplingPart 3 on Sampling

These maps of STLThese maps of STL Where is the evidence in this paper that Where is the evidence in this paper that

there is any reason to care about there is any reason to care about sampling?sampling? Where are the tables of rents by city?Where are the tables of rents by city? P. 29 why do we care about sampling until we P. 29 why do we care about sampling until we

are told that there are different %price are told that there are different %price ΔΔs s across types or citiesacross types or cities

We know house price inflation is different We know house price inflation is different across cities, but where is the evidence on across cities, but where is the evidence on rents?rents?

Finally, about GvGFinally, about GvG

That paper is about a century of house That paper is about a century of house price changesprice changes

It says there is relatively little It says there is relatively little difference between the AHS sample difference between the AHS sample and the CPI for 1997-2003and the CPI for 1997-2003

That doesn’t mean you can disregard That doesn’t mean you can disregard everything it says about 1914-1995 everything it says about 1914-1995

You fail to link its conclusions to your You fail to link its conclusions to your methdological discussion of 1967-methdological discussion of 1967-19831983