What Is the Connection between CPI and Housing Prices?

A consumer price index (CPI) often includes an element of the money consumers spend in the housing market, but countries often debate the best way to include this information to correctly reflect consumer spending on this necessity. CPI and housing are always related, but the way the two issues interact depends on a country's economic policy. Some economists want the relationship between CPI and housing to be parallel, so that housing prices are a correct reflection of inflation. Other economists feel that housing is not a consumable and should not be tied to this value at all. In this case, housing prices can be inflated while the CPI, the measure of inflation, is low.

Inflation is an increase in the costs of goods that outpaces consumer earnings. The practical way to illustrate inflation is to see what a certain amount of money would buy in a base year, and then compare what that same amount of money would buy in a later year. If the money buys less than it did in the base year, prices have inflated. Governments consider inflation to be a primary threat to a stable economy, because rampant increases in prices mean that an economy has to continue to grow to enable its citizens to make enough money to maintain their standard of living. Growing an economy is often difficult and relies on factors outside of a government's control, so the better solution is to keep inflation in check.

Governments measure inflation by keeping tabs on the CPI. This value keeps track of the changes in prices of a cross section of thousands of consumer goods and services purchased by urban households. Most countries handle CPI and housing carefully. They want housing included in this figure because it is a basic necessity that is consumed by everyone, but housing is also a long-term consumable that is not bought and sold frequently.

The way most governments solve the issue between CPI and housing is to include rents, but not housing sales, in this figure. Most analysts feel that rent is a proper measure of the cost of consuming housing in the short-term and the monthly equivalent of owning a home. Housing, it is argued, is an investment that is designed to be held for a long period, like stocks and bonds which are also not included in the CPI.

There are downsides to treating CPI and housing in this fashion. If actual housing prices are not part of the CPI, it is possible for prices to be inflated, without a parallel rise in the index. Without a rise in an economic indicator, no one can know when housing prices are outpacing consumer income since prices are not tied to an appropriate measure. In this scenario, CPI is misleading as an indicator of the health of the housing market. It does not warn of housing inflation, which can lead to a housing market bust that can negatively impact the economy.