Oil is big scary, housing is big scary too

Oil is stealing every headline and housing wants to tag along.

Inflation is a suspiciously round number. It probably belongs to an equally suspicious character rounded by the weight of all 516 pages in the Harmonized Index of Consumer Prices Manual.

But where does he, or the people that have made him up, actually spend?

Representative agents are a tool and a fiction – they look well in models and are helpful for conclusions. Human thought is often simplifying and finds its support in abstractions. It seems natural that the first thing that economists would look to simplify would be the human. And there it is, the ravishingly, disturbingly complex being reduced to rational choice and numbers of optimally expected utility. How poorly have we painted ourselves. New macroeconomic models bring more colors with which to paint mankind, and as a result the picture becomes increasingly difficult. So, do the current models that account and forecast inflation sit in black and white?

Going back to the manual, under a familiar grey of Brussels paperwork, we are confounded by a blur – all colors, all peoples are in the aggregate monetary expenditure spat. Everyone, in the sense that everyonetogether consumes thyme, chiropractor services and bedsheets, even though that the probability of this writer and this reader even jointly spending on any of the three is very slim. And when even just one is touched, the number moves. Here it is protected from great movements by its own roundness. Even if thyme goes extinct for some reason, its pressure on the price index is a lot of decimal points down from the usually reported one or two.

So is the agent even representative, or is his consumption a telling basket of goods and services? Yes and no. He is the exact account of how all households surveyed in every half-decade consume. Again, together, and in a way that to some their consumption will look a lot different from the picture they’re helping to paint. But no, he is not the result of rationalized behavior in a classical economic model way.

Figuring out whether the survey is truthful, we’ll make difficult questions along the way – is the survey random, and fair? And are we sampling enough people to paint the biggest picture? Do we keep things certain things out? Misrepresentation would be overwhelmingly costly – from central bankers and financial investors to this writer and this reader, who are probably neither.

The latter is most worrisome. Excluding for example housing from measure could be hurtful, for the people that make policy and the people that live under it. Persistent underestimation of price growth creates a permanent divergence between what people are told and people feel at the end of the day.

There is a technical reason why the price of owner-occupied housing is excluded from the European inflation number. Member-states do not have the statistics yet in a consistent enough way to meet harmonization. Including housing on the index should also exclude imputed or simulated prices, because we’ve based it on real-life transactions, so simulations on lifetime interest on a new mortgage loan would be confusing. Additionally, housing is also a financial asset, and the index tracks consumption prices, not investments. So rentals got in, under services, and so did maintenance and utilities expenditures on housing that is owned.

But prices of houses themselves, that big scary on the news? Nothing, especially when about a fifth of European disposable incomes get spent on housing, and a quarter pay interest on mortgage loans every month that’s worth almost half their incomes.

Here the union looks very much broken apart, as the price of a home is radically different within and between countries. But we’ve looked at the many shades of aggregation, and the spat could work again. Payments made on housing loans should be included in the index, and if policy interest rates keep stable, they should track the price growth of the underlying. And even if we happen to overrepresent lower income households – if the survey is that poor – and housing expenditure is blown up, the mess is better than a blank page. It can lead us to the right questions and the right policy.

And when oil looks gloomy, as it does right now, the narrative picks up on oil far more than housing, despite expenditures on oil and gas being an order of magnitude below at the average – 4 against 30 percentage points of Europeans’ disposable incomes spent on housing. Inflation expectations, or the guesses that economists, businesses and consumers make about our number, move significantly around oil shocks, while housing prices seems to creep in silence.

So when oil and inflation are again paired in every headline, think of the all-important round number, and what it’s still keeping a closed eye to.