Housing prices and inflation in the Euro Area

The inflation measure used by the European Central Bank excludes housing costs that are borne by home owners even though they make up more than a tenth of household final consumption expenditure in the euro area. Has the exclusion of owner occupied housing costs driven a wedge between the official harmonised index of consumer prices (HICP) and the cost of living? To answer this question, a measure of the user cost of housing capital has been constructed for every euro
area country (except Luxembourg). User costs are measured taking into account property taxes but net of tax breaks that home owners enjoy on mortgage repayments. The user cost measure is combined with the HICP to derive a "broad" inflation estimate. For the sake of comparison, an alternative estimate has been put together using imputed rents. The main conclusion is that owner occupied housing costs have an impact. Another important conclusion is that the effect of owner occupied housing costs on inflation varies noticeably with the method used to incorporate them into the price index. The paper finally discusses the choice of the method from the point of view of economic policy makers.