Real Interest Rates Are More Negative Now Than In The 2004-2007 Housing Boom

Real Interest Rates 2021-05

Meaning of Real

Real means inflation-adjusted. But what is the best measure of inflation?

Home Price Not in the CPI

Home prices are not in the CPI. They should be. Economists generally disagree with me, but what good is a measure of inflation that excludes key prices?

The CPI ignores housing prices, what corporations pay for health insurance on behalf of consumers, what Medicare and Medicaid pay for healthcare on behalf of consumers, stock prices, bond prices, speculation in cryptos, and only looks at the prices of so-called “consumer goods”.

Q: How relevant is the CPI as a measure of inflation? 
A: Not very if at all.

The Fed has ignored those things at its peril.

The result was:

  1. A DotCom bubble and a DotCom crash
  2. A housing bubble and a housing crash
  3. An even bigger bubble now 

Capital Expenses 

The reason economists ignore housing is they view it as a capital expense. So what? Are we measuring prices or just the ones that allow bubbles to be easily blown?

It's not possible to include prices such as stocks in the basket because they vary with earnings, but repeat sales of the same house and medical expenses are a different matter. 

Personal Consumption Expenditures (PCE), the Fed's preferred measure of inflation does take medical prices into consideration, but at the expense of even greater housing distortions. 

What the Chart Shows

The standard measure of "real" is made by subtracting year-over-year CPI from the Fed Funds Rate or 1-month T-Bill. 

Given that the Fed Funds rate is 0.06% and the year-over-year CPI increase is 4.99% the real interest rate is -4.93%.

But that does not include housing. The BLS housing component includes rent of primary residence weighted at 7.86% and OER weighted at 24.26%. 

OER stands for Owners' Equivalent Rent. It is an estimation of what homeowners would pay in rent if they rented their own house, from themselves, unfurnished, without utilities. 

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