Selected Issues Papers

This paper evaluates the policy implications of changing the methodology for calculating the cost of owner-occupied housing in the CPI from a “user cost” approach to “rental equivalence” approach. A synthetic historical CPI series based on the new methodology is created to develop a counterfactual policy scenario in IceQMod, a new Iceland-specific quarterly macroeconomic model based on the IMF’s Quarterly Projection Model (QPM). The new methodology would have resulted in slightly lower but more volatile inflation, potentially allowing for a looser monetary stance. The paper highlights the role that macroprudential tools could play to contain possible financial stability risks resulting from the change and the implications for the equilibrium interest rate and monetary policy.