The Concept and Methodology
In 1982, housing price data was removed from the CPI inflation series released by the Bureau of Labor Statistics. It was replaced by a concept called “Owners’ Equivalent Rent.” For Alternative CPI, we calculate CPI by removing Owners’ Equivalent Rent and replacing it with a housing price index. We decided to use the Case-Shiller 10 index as a primary replacement figure. Below, you can see a comparison of the Case-Shiller 10 vs. the CPI’s Owners’ Equivalent Rent concept. Clearly, there was a large divergence during the housing bubble years from 1997 to 2005, followed by another massive divergence during the bursting of the bubble.
The above chart looks at the increase in prices year-over-year, but to provide more perspective, you can the absolute values of the indexes (pegged to a base year) over time below.
Issues with Methodology
While there are inevitably flaws with any sort of methodology that attempts to come up with a broad measure of CPI, we believe that using the Case-Shiller 10 index provides a more accurate measure of inflation. When we use “Alternative CPI” measures, we are using this measure unless otherwise indicated. It is also reference as “Alternative CPI #1-A” at some places in the site.
One flaw with our methodology is that Case-Shiller only looks at housing prices in the larger metropolitan areas. While this is a limitation, it’s also true that larger metropolitan areas with supply constrained markets are a better gauge of problematic inflation issues. Another insight here is that the a substantial chunk of the US population lives in the 10 largest metropolitan areas.
We could expand this coverage further by looking at the Case-Shiller 20 index. Indeed, we use the Case-Shiller 20 in some of our charts. It will be labeled as Alternative CPI #1-B when used. However, we conducting our analysis, we found that the historical differences between the Case-Shiller 10 and the Case-Shiller 20 were not all that significant. You can see the differences in the chart below:
There are some minor differences in the housing boom years, with the Case-Shiller 10 occasionally drifting from 100 to 200 basis points above the Case-Shiller 20, but this does not radically change our analysis. Therefore, given the longer timeframe of available data for the Case-Shiller 10, we feel it is a more adequate measure.
Overall, we do not want anyone to take our measure as a dogmatic “ONE TRUE” measure of CPI. We do not believe such a measure exists. We are dealing with estimations with inflation and we believe evidence suggests that our estimations embodied in “Alternative CPI” are a better measure of true inflation in the United States that the current measure of official CPI inflation.