20 Feb 2020 16:39

Three common questions about inflation and housing prices

Forecasts indicate that Swedish inflation will fall far below the central bank’s target. At the same time, the price curve for housing is pointing upwards. When SEB's economists meet companies, financial institutions, private individuals, authorities, politicians, the media and students, it is almost always the same three questions about inflation targets, measurement methods and housing prices that emerge. Here, SEB's chief economist Robert Bergqvist answers them.

Question 1: Why is the central bank's inflation target at 2 per cent?

There is actually no scientific evidence for precisely 2 per cent. When the target was introduced in 1993, the Riksbank (Sweden’s central bank) – and other central banks – needed to find a "reasonable level". The level would partly be low enough to break a historical pattern with too high inflation and partly have a certain "safety distance" to zero.

Inflation that falls below zero can create expectations of price declines (deflation), which risks causing a self-reinforcing downward spiral for both GDP growth and inflation. Worth noting: global inflation has been around 2 per cent in the last 700 years, according to the Bank of England. It provides some support for the choice of 2 per cent level, even though the quality of statistics has swayed throughout history.

Question 2: Do we measure inflation correctly?

Statistics Sweden measures price changes for an average Swedish consumer. This means that there are 10 327 589 individual inflation rates in Sweden. The shopping basket that is used to calculate inflation is changed and re-weighted at each turn of the year to reflect any new patterns of consumption. You may have opinions about how new goods and quality adjustments should affect the CPI, but Sweden has a committee of academics and large users who give advice on how the CPI should be measured. Furthermore, the methods used are well documented. Changing the way inflation is measured because it is currently lower than, for example, the Riksbank wishes is not a good idea.

Question 3: Should housing prices not be included in the inflation measure?

No. In general, it is difficult to include different asset prices in inflation measures. In addition, housing prices do not follow the business cycle to a particularly high degree. In Sweden, instead, it is particularly clear that prices reflect a structural shortage of housing. A monetary policy (interest rate policy) that responds to structurally induced housing price inflation risks exacerbating the situation by making interest rates more expensive and dampening construction. Therefore, housing prices should not be included in inflation, although they can be considered in the overall monetary policy.