Parallel To Apparel Shocker


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Parallel To Apparel Shocker

  1. 1. Discussion of CNV and MP on the CPI for Shelter Robert J. Gordon Northwestern University and NBER Brookings Workshop on Economic Measurement, May 23, 2003
  2. 2. Tributes <ul><li>Congrats to the organizers for finding the right papers on the most important component in the CPI </li></ul><ul><li>Congrats to the authors for adding enormously to the body of knowledge </li></ul><ul><ul><li>About pitfalls in the CPI as they change over time </li></ul></ul><ul><ul><li>Using new data sets, esp. the AHS, to provide new perspective on potential sources of bias </li></ul></ul><ul><li>This topic is the BIG BANANA of CPI bias </li></ul>
  3. 3. Apostle of Upward CPI Bias? <ul><li>1990 The Measurement of Durable Goods Prices </li></ul><ul><ul><li>I still love my monthly Consumer Reports and sure miss the Sears Catalogue </li></ul></ul><ul><li>1996 Boskin Commission Report </li></ul><ul><li>BUT </li></ul><ul><ul><li>Relative prices change all the time </li></ul></ul><ul><ul><li>Now: many goods prices falling, but college tuition and plumbers’ fees keep rising </li></ul></ul><ul><ul><li>Just wait for the decline of the dollar to start boosting a wide variety of imported goods prices </li></ul></ul><ul><li>IN SAME WAY </li></ul><ul><ul><li>Bias can differ greatly across products, sometimes up, sometimes down, relative extent of bias changing over time </li></ul></ul>
  4. 4. Bias may change over time <ul><li>Hulten-Bruegel paradox </li></ul><ul><li>Nordhaus’ suggestion </li></ul><ul><li>Hulten’s response </li></ul><ul><li>Extend back to Bruegel </li></ul><ul><ul><li>¼ lb of potatoes vs. those prosperous-looking Dutchmen </li></ul></ul><ul><li>Resolution? </li></ul><ul><ul><li>Bias in durable goods (and Nordhaus for light) can’t be applied to necessities (food, apparel, shelter) </li></ul></ul><ul><ul><li>OR, bias in necessities changed over time </li></ul></ul><ul><li>Boskin Report: only 95-96, bias could have been higher or lower (or opposite sign?) at any point in the past </li></ul>
  5. 5. Prima Facie Case that the CPI for Shelter is Biased Downwards <ul><li>Change over long historical periods </li></ul><ul><ul><li>CPI for Shelter 1999/1925 = 5.1 </li></ul></ul><ul><ul><li>To get that number, see CNV Appendix 2, where on their base year, CPI (1925) = 34.5 (1940/1925!!) </li></ul></ul><ul><li>Median Price of Existing Houses </li></ul><ul><ul><li>Historical Statistics , Washington DC, 1925, $7,809 </li></ul></ul><ul><ul><li>Statistical Abstract, Washington DC, 1999, $176,000 </li></ul></ul><ul><ul><li>Ratio = 22.5, not 5.1 </li></ul></ul><ul><li>OK, rent vs. ownership price including land </li></ul><ul><ul><li>But CPI for shelter is used to proxy for home ownership price </li></ul></ul><ul><ul><li>Tenants pay for the land, not just the structure </li></ul></ul>
  6. 6. Another Example <ul><li>Historical Statistics, 1922 </li></ul><ul><ul><li>Residential Wealth $71.3 billion </li></ul></ul><ul><ul><ul><li>Structures $51.1 billion </li></ul></ul></ul><ul><ul><ul><li>Land $20.2 billion </li></ul></ul></ul><ul><ul><li>Number of housing units 19.5 million (why so few?) </li></ul></ul><ul><ul><li>Value per Unit = $3,656 </li></ul></ul><ul><li>Statistical Abstract for 1999 </li></ul><ul><ul><li>Net Residential Capital Stock $9,405 billion </li></ul></ul><ul><ul><li>Number of units 115 million </li></ul></ul><ul><ul><li>Value per Unit = $81,800 </li></ul></ul><ul><li>Ratio 1999/1925 = 22.1 not 5.1 </li></ul><ul><li>Could it ALL be quality change? </li></ul>
  7. 7. If the CPI-Shelter is Biased Downwards, Over What Interval? <ul><li>CNV makes a convincing case that bias less in 90s than before (MP limited to 89-01 interval) </li></ul><ul><li>Ingredients in Change over Time: CNV Key Point that Rent Increases Occur with Tenant Turnover </li></ul><ul><ul><li>1942: obtain rent from tenants rather than landlords (WWII rent controls) </li></ul></ul><ul><ul><li>Mail survey 1942-63: nonresponse rate </li></ul></ul><ul><ul><li>Telephone survey still misses tenant turnover </li></ul></ul><ul><ul><li>1978: interview landlord or tenant every 6 months </li></ul></ul><ul><ul><li>1988: aging bias correction </li></ul></ul><ul><ul><li>1994: recall bias correction </li></ul></ul>
  8. 8. Shocking Sources of Downward CPI Bias in the Past <ul><li>The “Case of the Disappearing Tenant” </li></ul><ul><ul><li>Why Emphasis on 6 month changes? </li></ul></ul><ul><ul><li>Why Not Structure Data Collection Around 12 month change? </li></ul></ul><ul><ul><li>I am a landlord: I know the history of both price and quality change </li></ul></ul><ul><li>Parallel to Apparel Shocker: “The Case of the Dress that Goes on Sale” </li></ul><ul><ul><li>Ride the Sale Price Down </li></ul></ul><ul><ul><li>Link Out the New Dress at the Regular Price </li></ul></ul><ul><li>Apparel + Housing Resolve the Hulten-Bruegel Paradox (But don’t overturn Boskin) </li></ul>
  9. 9. Implications of CPI Bias <ul><li>CNV (and Weston) create presumption that bias was greater 1942-78 </li></ul><ul><li>Growth in real consumption and real GDP overstated </li></ul><ul><li>Golden age of productivity growth 1940-70 overstated </li></ul><ul><ul><li>Less of a productivity growth slowdown after 1970 </li></ul></ul><ul><ul><li>Low Bias in 1990s implies bigger productivity revival </li></ul></ul><ul><li>2% annual bias for 30% of the CPI implies 0.6% annual upward bias for real consumption, 0.4% for real GDP </li></ul><ul><ul><li>These are big numbers in the “battle of the basis points” </li></ul></ul>
  10. 10. CNV Paper <ul><li>Real Addition to Our Knowledge </li></ul><ul><li>Terrific History of CPI Methodology since 1942 </li></ul><ul><li>Long-period Time Horizon </li></ul><ul><li>Micro Data </li></ul><ul><ul><li>BLS Micro Data Set </li></ul></ul><ul><ul><li>AHS Hedonic Regressions </li></ul></ul>
  11. 11. First, Let’s Correct those Little Errors <ul><li>Abstract says “CPI for rent over 1940-77 may have been overstated by 1.5 percent annually” </li></ul><ul><li>Appendix 2 says 1.8 percent not 1.5 percent </li></ul><ul><li>Overall Bias Result from Appendix 2 </li></ul><ul><ul><li>1940-78 -1.80 </li></ul></ul><ul><ul><li>1978-88 -1.16 </li></ul></ul><ul><ul><li>1988-2002 -0.03 </li></ul></ul><ul><li>Absence of bias after 1988 a stunning result, just as is -1.80 before 1978 </li></ul>
  12. 12. What Did I Think Beforehand? <ul><li>1940-70 Weston’s Thesis </li></ul><ul><li>1970-99 Regressions from AHS Summary Data </li></ul><ul><li>Slightly Different Periods, but same general pattern: </li></ul><ul><ul><li>1940-75 -3.49 </li></ul></ul><ul><ul><li>1975-91 -1.34 </li></ul></ul><ul><ul><li>1991-99 +1.79 </li></ul></ul><ul><li>Open Questions: </li></ul><ul><ul><li>Interpretation of Weston 1940-70 </li></ul></ul><ul><ul><li>CNV More Reliable 1975-99 </li></ul></ul>
  13. 13. My Little Corner of the World <ul><li>Historical rent index for Evanston IL </li></ul><ul><ul><li>Many versions, hedonic, nonhedonic, identical addresses etc. </li></ul></ul><ul><ul><li>Source: newspaper advertisements going back to 1925 </li></ul></ul><ul><li>Implications: CPI minus Evanston </li></ul><ul><ul><li>1925-40 -0.94% </li></ul></ul><ul><ul><li>1940-80 -1.43% </li></ul></ul><ul><ul><li>1980-90 -0.02% </li></ul></ul><ul><ul><li>1990-99 +0.05% </li></ul></ul>
  14. 14. Issue We Shouldn’t Take for Granted: Aging Bias <ul><li>CNV Take This at Face Value </li></ul><ul><li>Yes, Clearly a Source of Downward CPI Bias in the Past </li></ul><ul><li>But What does it Mean? </li></ul><ul><ul><li>Location: Inner-city vs. Suburbs </li></ul></ul><ul><ul><li>Omitted quality variables from my perspective as an Evanston landlord: </li></ul></ul><ul><ul><ul><li>New high-rises have views </li></ul></ul></ul><ul><ul><ul><li>Central air conditioning, new kitchens </li></ul></ul></ul><ul><ul><li>But do the older units actually decline in quality? </li></ul></ul><ul><ul><ul><li>My coach house says “no”! Renovations not only by owner but by tenants! </li></ul></ul></ul><ul><ul><ul><ul><li>Distinction between maintenance (roof, gutters) vs. improvements (e.g., circuit board, kitchen appliances, new and better floors) </li></ul></ul></ul></ul>
  15. 15. Where Do the CNV Estimates Come From? <ul><li>Model, Apply corrections for new renters, recall bias, vacancy imputation while using CPI estimates of aging bias </li></ul><ul><li>Credibility test for 1940-77 </li></ul><ul><ul><li>Their model bias -1.8% </li></ul></ul><ul><ul><li>Median gross rent 1940-77 -2.6% </li></ul></ul><ul><ul><li>Implies quality change ~+0.8% </li></ul></ul><ul><ul><li>This seems very plausible </li></ul></ul>
  16. 16. Closer Look at 1975-87 <ul><li>Growth Rates from their Table 12 </li></ul><ul><ul><li>CPI minus Median Gross Rent -1.70% </li></ul></ul><ul><ul><li>CPI minus their adjusted index -1.78% </li></ul></ul><ul><ul><li>CPI minus their hedonic AHS index -2.00% </li></ul></ul><ul><li>Median Gross Rent vs. Hedonic </li></ul><ul><ul><li>Implies quality decline of -0.3% per year </li></ul></ul><ul><ul><li>They don’t comment on this </li></ul></ul><ul><ul><li>Is it credible? </li></ul></ul><ul><ul><li>Could it be a location phenomenon – south, suburbs? </li></ul></ul>
  17. 17. Puzzle of Repeat Rent Measure <ul><li>Blank in Cell 1983-85 (Table 12) </li></ul><ul><li>Average for 1975-87 omitting 83-85 </li></ul><ul><ul><li>CPI minus AHS Median Gross Rent -1.74 </li></ul></ul><ul><ul><li>CPI minus their model -1.92 </li></ul></ul><ul><ul><li>CPI minus hedonic AHS -1.86 </li></ul></ul><ul><ul><li>CPI minus AHS Repeated Rent -0.20 </li></ul></ul><ul><li>Why? They don’t know (p. 28) </li></ul><ul><ul><li>This is where the MP paper should help, but it doesn’t </li></ul></ul><ul><ul><ul><li>Implied quality improvement missed by hedonic index is not credible </li></ul></ul></ul><ul><ul><li>Is the CNV Repeated Rent Index Identical in Principle to the MP index? (Homework Assignment) </li></ul></ul>
  18. 18. So MP Step In Regarding AHS <ul><li>Interesting Hypothesis: Bias by Insufficient Sampling of Top Part of Market </li></ul><ul><li>Recall Paul Pieper on Residential Housing: Omission of 2000+ sq. ft. houses biases down housing inflation by ~1% per year </li></ul><ul><li>Is it something special about top of the market or unmeasured quality attributes? </li></ul>
  19. 19. MP Paper Disappointing <ul><li>Sample Period only 1989-2001 </li></ul><ul><ul><li>They Miss the Big Period of CPI Bias pre-1989 </li></ul></ul><ul><ul><li>Why Don’t They Exploit the AHS 1975-89? </li></ul></ul><ul><li>Why Don’t They Cumulate Their Own Results and Convert to Annual Rates? </li></ul><ul><ul><li>Charts 4 and 5. </li></ul></ul><ul><ul><ul><li>Tenant Rent CPI minus their AHS index +0.37 </li></ul></ul></ul><ul><ul><ul><li>OER CPI minus their AHS index +0.77 </li></ul></ul></ul><ul><ul><ul><li>Significant Conflict with CNV paper </li></ul></ul></ul><ul><ul><li>Their short-run orientation is unconvincing and, in this crowd, uninteresting. We care about decades, not two-year intervals </li></ul></ul>
  20. 20. Nitpicks <ul><li>P. 4: “[the pre-1983 CPI treatment of housing was] analogous to the CPI’s current treatment of automobiles and other consumer durables. </li></ul><ul><ul><li>NO! The current CPI is MUCH better than that! </li></ul></ul><ul><ul><li>Poor explanation of what was wrong with CPI pre-1983. </li></ul></ul><ul><ul><ul><li>Wrong weights, applying the current mortgage rate to all outstanding mortgages </li></ul></ul></ul>
  21. 21. Big Issue of Principle: OER Costs <ul><li>MP (p. 10) includes </li></ul><ul><ul><li>“ Cost of Capital” equals value of the property net of 8 percent transaction costs </li></ul></ul><ul><ul><li>Times “The yearly average of the 30-year fixed mortgage rate minus ½ percentag point” </li></ul></ul><ul><ul><li>Add “real estate taxes, utilities, insurance costs” </li></ul></ul><ul><ul><li>Add depreciation = 1% of property value </li></ul></ul>
  22. 22. What if Mortgage Interest Declines from 7.0 to 5.2 over Two Years? <ul><li>Property Value net of 8% = $200,000 </li></ul><ul><li>Mortgage Component falls from $14,000 to $10,400 </li></ul><ul><li>Say Taxes, utilities, etc. = $7,000, increasing at 4% per year </li></ul><ul><li>Depreciation = $2,000 </li></ul><ul><li>Total OER cost declines from $23,000 to $19,970 </li></ul><ul><ul><li>Annualized inflation = -7.06% </li></ul></ul>
  23. 23. Why We Don’t Want Mortgage Rates in the CPI <ul><li>Didn’t We Settle This in 1983? </li></ul><ul><li>These Fed Economists are Monetary Policy Imperialists </li></ul><ul><ul><li>The Fed Controls the CPI! </li></ul></ul><ul><ul><li>This Nonsense Plagued the British CPI for years! </li></ul></ul><ul><li>Low Interest Rates Create Capital Gains, and we don’t want Capital Gains in CPI or GDP </li></ul>
  24. 24. Dramatic Example of Why We Don’t Capture OER Inflation with CPI for Rents <ul><li>My friend: </li></ul><ul><ul><li>Condo worth $225K </li></ul></ul><ul><ul><li>Annual Rental $19,800 </li></ul></ul><ul><li>Apply this to a $1 million house, of which there are a LOT </li></ul><ul><ul><li>Implies monthly rent = $7,333 </li></ul></ul><ul><li>Where is the rental market for $7,333 per month houses? It doesn’t exist for good reasons that home ownership makes big houses very cheap </li></ul>
  25. 25. Two Alternatives for OER <ul><li>Option #1 </li></ul><ul><ul><li>Take seriously the role of capital gains in making homeownership cost virtually zero over time </li></ul></ul><ul><ul><li>Let housing costs in CPI ride the roller-coaster of the current mortgage interest rate </li></ul></ul><ul><li>Option #2 </li></ul><ul><ul><li>Pretend that capital gains don’t exist </li></ul></ul><ul><ul><li>Base CPI on rate of inflation in property taxes, insurance, utilities, and home maintenance </li></ul></ul><ul><li>I want our CPI and GDP deflator to be based on #2 not #1. How about You? </li></ul>