Study says Canada CPI doesn't catch housing bubbles

Wed Sep 12, 2012 5:00pm EDT
 
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OTTAWA (Reuters) - The Bank of Canada needs a better inflation indicator that captures housing prices properly so that it does not miss the effects of housing bubbles when it sets interest rates, a study by the C.D. Howe Institute think tank said on Wednesday.

In setting rates, the central bank aims to keep inflation, as measured by Statistics Canada's consumer price index, at 2 percent, but C.D. Howe senior policy analyst Philippe Bergevin said CPI is relatively insensitive to housing market price changes.(here)

"The main concern is that the CPI's insensitivity to housing could potentially cause the central bank - reassured by its imperfect indicators that inflation is under control - to keep rates too low for too long," his report said.

"Of course, the Bank of Canada has access to a wide array of data that provide information on the housing market but it is much harder for a central bank to adopt a restrictive monetary policy, including from a communications perspective, if its actions cannot directly be linked to its inflation-targeting mandate, as reflected in its official inflation indicator and target."

He said for similar technical reasons, the U.S. Federal Reserve's favored indicator - the price index for personal consumption expenditures - did not capture the recent housing boom and bust in the United States.

Statscan's CPI indicator uses assumed prices for dwellings rather than actual prices for housing, and the inclusion of a mortgage interest component may actually end up acting perversely.

"As currently measured, the housing component of the CPI drops when interest rates fall, which sends the wrong signal about inflation since lower rates support higher-than-otherwise housing prices," Bergevin said.

The chief of research in Statistics Canada's CPI division, Marc Prud'Homme, said the government agency's reports, to some extent, do reflect housing prices. He said Statscan tries to separate the consumption cost of a home from the investment cost, and therefore its reports include figures on depreciation, taxes and mortgage costs.

"With regards to purchasing a house, there's no generally accepted way of accurately capturing that portion of a house price which would be defined, if you want, as consumption," he said.

He said the difficulty with trying to measure home ownership costs is so great that some countries, like France, leave it out of their consumer price baskets altogether.

(Reporting by Randall Palmer; Editing by Peter Galloway)