by Calculated Risk on 4/05/2010 08:00:00 PM

Some people have argued that measured is inflation is declining mostly because of the Owners' Equivalent Rent component that is being pushed down by the record high rental vacancy rate. Economists at the San Francisco and New York Fed argue that there is "a broad pattern of subdued price increases across most consumption goods and services and [housing] is not distorting the broad downward trend in core inflation measures."

From Bart Hobijn, Stefano Eusepi, and Andrea Tambalotti: The Housing Drag on Core Inflation

Click on graph for larger image in new window.

One way to consider the effect of the price of housing on core inflation is to calculate a core PCEPI that excludes housing. This is done in Figure 1, which contains three time series. The first is 12-month growth in the core PCEPI. The second is a comparable measure of inflation for the housing component of the core PCEPI. The final time series is a core PCEPI that excludes housing expenditures.

Three things stand out in this figure. First, the standard core inflation measure shows substantial disinflationary pressures at work. ...

Second, part of the drop in measured core inflation is undoubtedly due to the deceleration in the price of housing. ...

Third, it turns out that this drag is rather small. The decrease in housing inflation only accounts for a small part of the overall disinflationary pressure on core PCEPI. ...

Consequently, the evidence in Figure 1 offers little cause for concern that the recent behavior of core inflation might be a misleading signal of the underlying inflation trend.
emphasis added

Note: The measures of housing inflation try to separate the cost of living in a home from changes in the asset price.

The Fed has a dual mandate of price stability and maximum sustainable employment. This disinflationary trend (ex-housing) is important because some people at the Fed are more concerned about possible future inflation, whereas others are more concerned with the high level of unemployment.