A headline at CNN’s money page caught my eye recently: “Why house prices will keep falling.”
The article cited the Case-Shiller U.S. House Price Index, which showed a 3.1 percent decline from January 2010 to January 2011. The gist of the index, developed by Karl Case and Robert Shiller, is that home prices tend to follow inflation.
On the surface, that seems obvious. Inflation, which probably should be called price inflation, is just that—increases in prices relative to the value of the dollar. Most prices, including prices paid for homes, increase steadily over time, and economists use these increases to calculate inflation. Economists often separate food and fuel because they are volatile, leaving core inflation, which tends to be steady. Case and Shiller did something different. Instead of pulling out fuel and food, they separated house prices. According to their research, home prices generally follow inflation. The key is that they generally follow inflation; when home prices diverge from core inflation, Case and Shiller expect them to later realign. If home prices rise faster than other prices, home prices later fall. (more...)