Question

The Office for National Statistics (ONS) in the UK last year proposed a new price index-a CPI that includes housing costs-called the CPIH. The rationale given for this proposal is that

"the biggest cost for most homeowners is the cost of repaying their mortgage. But mortgage interest payments are not included in the CPI, nor are a variety of other costs, such as house depreciation, buildings insurance and ground rent, and house transaction costs such as estate agents' fees, survey costs and conveyancing charges. Council tax is not included in the CPI either."

Briefly evalute this proposal. What are its advantages and disadvantages? How do you think the CPIH would have behaved in the past 5 years relative to the CPI? Would the CPIH be a useful inflation target measure?

Answer 1

Including the house mortgage prices in the CPI is a very valid proposal, as it is indeed a major part of a person's expenditure. Not just the mortgage on the house already bought, for the ones who are staying on rent, rental expenditure is also a very important part of their expenditure. The advantages og including this can be as follows -

1.) The normal CPI does not include real estate attributes like the ones mentioned above, and hence it is not a suitable measure of the level of inflation in the country

2.) CPI data is used to reflect on the level os wages in the economy and if eages do not attribute for housing expense, then it will be indeed difficult for poeple to manage their expenses

There can also be certain disadvantages of the same -

1.) Real estate values are ever-increasing, and including them in the CPI will overstate the inflation rate in the economy

2.) If house depreciation is factored in, it would enable the CPIH values to become lower and lower, which still does not reduce the cost incurred to build the hosue and hence the mortgage value of the same.

In the last couple of years, the housing market has seen declining prices, and this would mean that the CPIH will be lower as compared to the CPI. This can be a useful inflation target measure, but it has to also include the trend of the rental housing market, as the house rent has been increasing as more and more people resort to renting rather than buying their own houses.