Towards an applicable true cost-of-living index that incorporates housing

Abstract

There is no international consensus about the treatment of the price of housing services in a consumer price index. A number of different approaches, more or less ad hoc, are used in practice. In this paper a semi dynamic model of consumer behavior that incorporates the demand for housing is specified such that it is consistent with the general purpose of a consumer price index. From this model a true cost-of-living index that includes housing is derived. Being an ideal index it cannot be computed without imposing additional assumptions about the behavior of the consumer, but it is possible to draw conclusions about the prices and weights that should be used in conventional approximations to such an ideal index. It is demonstrated that a price index can be computed that is consistent both with theory and the general purposes of a CPI using conventional approaches and data that are available at most statistical agencies.