1. Housing and the Consumer Price Index Martin Weale Consumer Prices Advisory Committee and External Member, Monetary Policy Committee

2. What is Consumption? A flow of goods and services, produced by the use of factors of production, such as labour, capital and land whose enjoyment increases people’s welfare. Economists focus on marketed consumption with the major exception of owner-occupied housing. A consumer price index index should focus on the prices of consumption- the tax and price index attracted little interest.

3. Anomalies Domestic work is left out unless remunerated. Leisure may increase welfare but is not treated as consumption. Durable goods, even with a physical life of many years, are treated as though they are consumed when bought.

4. Why focus on housing? 1.Housing much more durable than many other durable goods. 2.Much more capital tied up in housing than in durable consumption goods. 3.Substantial differences between countries in owner-occupation patterns. 4.Substantial shifts in patterns of owner occupation over time.

5. The Payments Approach Treat interest payments as consumption of housing- as in current RPI. Main objection. Interest payments are not a purchase of a good or service. If they were we would want to treat all debt interest as consumption or as an input into production. Would imply that output, income and consumption rose as economies increased their gearing. Land is not produced and cannot be consumed.

6. Net Acquisitions Treat housing in the same way as other consumer durables. Objections- treatment of other durables is a simplification, not a desideratum. Net acquisitions of housing could be negative- meaning that rising house prices depress the price index. In UK not easy to separate acquisition of land from acquisition of housing.

7. User Cost Requires assumption about cost of capital. Results depend on whether capital gains are treated as anticipated or unanticipated.

8. Rental Equivalence Gives most plausible estimate of the cost of using the capital tied up in housing. Treats investment in housing like other forms of investment. Consistent with real increase in output of housing coming only from extra investment in housing.

9. House Price Booms The rental equivalence measure does not show house price booms. These are largely land price booms and only poor measurement shows them in the net acquisitions measure. They are reflected in the payments measure but in large part because it shows the cost of acquiring land which is not a consumption good. Land price booms redistribute resources from young people to old people: there are gainers as well as losers.

10. Conclusions A single index number cannot be expected to measure everything. A consumer price index is not an indicator of living standards. Policy-makers need to take account of house prices and other prices of capital assets but this does not mean they should be in the consumer price index. But the question whether CPIH should replace CPI as the inflation target is one for the Chancellor of the Exchequer and not for the MPC.