Why the Fed Continues To Cut Rates

The charts below originally appeared in a post that appeared in August. Over the weekend, a reader asked for an update and the results are below.

The first chart shows the S&P Case-Shiller Home Price Index (by far, the best indicator of home prices in the U.S.), versus the proxy for home prices used in the Consumer Price Index - the nefarious owners equivalent rent.

[Note: For those new to this subject, be advised that the government's inflation statistics do not track home prices directly. Instead, they use an estimate of what homes would rent for - yes, it sounds and is a very dumb thing to do. Also see "Homeownership Costs and Core Inflation" from a couple years ago where all the gory details are explained.]

So, what would the consumer price index look like if real home prices were used instead of owners' equivalent rent?

The last couple months of plunging home prices would take the annual rate of inflation to zero as shown below (actually, it's still positive at 0.01%).

And, yes, a big reason why we are in the mess we are in today is that inflation, with real home prices included, was much, much higher than inflation with OER back in 2003, 2004, and 2005 when interest rates and lending standards were at multi-generational lows.

The chart below should be of keen interest to the dismal scientists at the Federal Reserve since core inflation (excluding food and energy) with real home prices has now entered negative territory with the addition of fresher data.

Of course you won't hear this from anyone at the Fed, but the shape of these curves is a very big part of the reason why short-term interest rates were cut last week and why they are likely to be cut again many times over the next year or so.

Comments

[Still Renting:]

As a former home owner who has rented the last several years, I can vouch for that renters blue line. It was fascinating to watch home prices soar while my rent remained flat - maybe even went down when I moved.

I also saw the home price inflation happening when "official" inflation figures were low. The graph explains why people felt like they had less and less even though the government figures helped them look elsewhere for the source of their financial pain.

Of course, the REAL hidden inflation here was in the increase in taxes.

2007 Nov 06 09:57 AM

[kdo:]

Actually I would suggest your charts show exactly why the Fed includes OER instead of housing prices directly and exactly why it would be stupid not to.

A house is an asset, which should be linked in *VALUE* according to what you can equivalently rent it for. That's why watching housing prices skyrocket, you should know absolutely that this has nothing to do with inflation. If it were "real" inflation - as a monetary phenominon, rent would be keeping pace.

2007 Nov 08 06:53 PM