1 Price Indices: Part 4 MEASUREMENT ECONOMICS ECON 4700

2 This part… Problems areas and issues for the CPI –The treatment of shelter –Plutocratic vs. Democratic weighting –The treatment of quality change

3 Shelter in the CPI –Problem Investment or consumption? –Shelter is an important expenditure Shelter = 27% Owned accommodation = 16%

4 Shelter in the CPI Six various measures are presented based on four different concepts –Statistics Canada’s Official Concept (user cost) –Rental equivalence –Money outlays (payments approach) –Net purchases (acquisitions approach)

5 Shelter in the CPI Official concept –Definition: Measures the price induced changes associated with the cost of owning and using a given stock of owner-occupied dwellings. Includes actual and imputed costs. –Advantages: Covers elements similar to those that a landlord factors in when fixing rents.

6 Shelter in the CPI Rental equivalence –Definition: Imputes changes of market rents to the population of homeowners. –Advantages: Consistent with the national accounts. Isolates the consumption flow of owner- occupied housing from the savings flow.

7 Shelter in the CPI Money outlays (payments approach) –Definition: Measures price induced changes associated with the consumption related payments of owner-occupied housing. –MO 1: Excluding equity payment –MO 2: Including equity payment –Advantages: Reflects actual costs to homeowners for their shelter. No imputation or notional amounts are involved. Most of the population would identify their own home ownership experiences with this concept. Escalator of money incomes

8 Shelter in the CPI Net purchases (acquisitions approach) –Definition: Measures changes in market (transaction) prices for owned accommodation (with or without mortgage interest charges). –= purchases of new and existing owner-occupied dwellings minus sales of such dwellings –“Net” purchases of existing dwellings is insignificant therefore net purchases = new purchases. –NP 1: Based on purchases –NP 2: Based on down payments and discounted mortgage payments (Alan Blinder, 1980) –Advantages: Preferred measure for monitoring inflation and for monetary policy.

9 Shelter in the CPI No owned accommodation Definition: Simply exclude homeownership from the CPI. Housing is an purely a financial asset. –Advantages: Easy solution and compatible with the current HICP and other country practices.

10 Shelter in the CPI Commodity groupOFFICIALREMONEY OUTLAYSNET PURCHASE EXCLUDING EQUITY PAYMENT INCLUDING EQUITY PAYMENT PURCHASESDOWNPAYMENTS AND MORTGAGE PAYMENTS Homeowners’ maintenance and repairs Condo charges Property taxes Insurance premiums Mortgage insurance Mortgage interest charges Replacement cost 19.5 Real estate commissions Legal fees Other shelter services Equivalent rent 90.7 Down payments (NP2) 15.2 Home purchase (NP1) 47.8 Discounted Mortgage payments 31.9 Net equity = Down payment + principal share of payment - sale of house 17.4

11 Shelter in the CPI Commo- dity grouping OfficialRental equiva -lence Money outlays Net purchase No equity pmt With equity pmt Purchases Down pmt and mgt pmt Shelter All- items

12 Price Index Series for Owned Accommodation (January 2000 = 100)

13 Price Index Series for All items using NHPI (January 2000 = 100)

14 Shelter Owned accommodation ShelterAll-items Official Rental equivalence Money outlays (1) Money outlays (2) Net purchase (1) Net purchase (2)

15 The NHPI

16 Democratic vs. Plutocratic Democratic: An index in which each household index is given equal weight Plutocratic: A price index in which all dollars of expenditure are treated equally, so that, implicitly, each household is weighted proportional to its expenditures.

17 Democratic vs. Plutocratic

18 Democratic vs. Plutocratic

19 Democratic vs. Plutocratic

20 Democratic vs. Plutocratic

21 Democratic vs. Plutocratic

22 Democratic vs. Plutocratic The last equation tells us that you a democratic Laspeyres price index can be estimated if we can calculate, in addition to the price relatives, the population average of the household budget shares. The merits of the democratic index which gives every household an equal weight in the CPI are ideal for welfare analysis and income indexation. If you want every dollar to count the same (e.g., deflation in national accounts), then you are better off with a plutocratic index.