Calculation of owner occupied housing in CPI, August 2004

The calculation of owner occupied housing in the Icelandic CPI is based on one hand on  changes in the market prices of sold properties and  on the other hand on the assumed lifetime of the properties (depreciation) and the long time real interest rate (opportunity cost)  of the investment in housing.

The composition of the real interest rates in the calculation model that Statistics Iceland uses is based oninformation obtained from sales contracts collected by the Land Registry of Iceland. Approximately two thirds of the rates do not change from month to month as these are  rates on the owners own equity and on old mortages. In the category “other interest rates” the real rates for mortages from the Housing  Fund form the largest category and they have been relatively stable over the last ten years.

The lending by the Housing  Fund was changed in July 2004 by introduction of loans in cash, ÍLS mortages, that replaced the former housing certificates and bear lower real interest rates . In the calculation of the CPI in July, Statistics Iceland did take into account the lowering of the interest rates of the housing  loans as it leads to the lowering of the level of real interest rates. This  is in accordance with thepractice adopted when similiar real rate changes occurred previously,  for example at the end of 1993 when the mortage rates were lowered from 6% to 5% and in the beginning of the year 1995 when they rose from 5% to 5.1.

In the new lending system, the real interest rates are seteach month. For CPI purposes, this could be a challenge to the stability of the real interest rates used in the calculation of the user cost. The long time real interest rates used in the calculation are set in accordance with the lifetime of the house and it would therefore not be appropriate if short term changes in the real interest rates would have major influence on the monthly price measurement. Because of this, it is necessary to extend the model level of real interest rates over a longer period of time.

Statistics Iceland has decided that as of August 2004 the real interest rates used will be calculated as a five year moving average. Initially, the average will be calculated for the period from March 2000 but at that time the  the house price index was extended to cover the whole country instead of the capital region covered previously. Hence, the first calculation will  cover 54 months. The rates will be changed each month and added to the average till they have reached 60 months in February 2005. In each month after that one month will be taken away and a new one added. This practice should ensure that the short term changes in the real interest rates of housing mortages will not cause significant volatility  in the monthly measurement of the CPI. On the other hand, it also secures that long term changes in the real interest rates are taken into consideration.