Housing inflation has proven to be a persistent factor contributing to the overall high levels of inflation in the United States economy. Despite a cooling trend in inflation rates across various sectors following the peak levels during the pandemic era, housing inflation has remained stubbornly high. This slow decline in housing inflation is identified as a major hindrance in achieving a normalization of the consumer price index (CPI) to the levels desired by policymakers and economists. With housing accounting for a significant 36% of the CPI index, it holds the largest share in comparison to other categories such as food and energy, reflecting its status as the primary expense for the average household.
Shelter prices, which are a component of housing inflation, play a crucial role in determining inflation readings. Shelter inflation is primarily a measure of U.S. rental prices, as explained by Jessica Lautz, the deputy chief economist at the National Association of Realtors. However, the calculation of shelter inflation by the Bureau of Labor Statistics (BLS) is identified as a factor leading to delays in reflecting real-time rental market trends in the inflation index. This lag in the adjustment of shelter inflation has been slower than anticipated by economists, with a modest decline observed from its peak levels.
A notable disparity exists between the glacial pace of shelter inflation in the CPI data and the current state of the rental market. While the annual inflation rate for new rental contracts has significantly dropped, the shelter inflation index continues to lag behind, resulting in a delayed reflection of market dynamics. Federal Reserve Chair Jerome Powell highlighted the significant lags in shelter CPI readings, indicating that it may take several years for the index to align with recent changes in the rental market.
The methodology used by the federal government to construct the housing inflation index presents challenges in reflecting real-time market trends. Homeowners are particularly impacted by the calculation methodology, as regular costs associated with homeownership are considered capital costs rather than consumption goods. This approach complicates the incorporation of owned housing units into the CPI basket, which primarily focuses on measuring changes in the prices of goods and services consumed by Americans.
The Role of Owners’ Equivalent Rent in CPI
To address the disparity between renters and homeowners in the CPI calculation, the BLS employs the “owners’ equivalent rent” (OER) category. This component aims to place homeowners on a level playing field with renters by measuring the theoretical rental value of owned homes. While this framework has been in use since 1987, its implementation faces challenges in accurately reflecting the evolving dynamics of the housing market.
Experts suggest that shelter inflation is expected to moderate gradually as it catches up with trends in the rental market. With a staggered panel sampling approach to construct the CPI shelter index, the slow movement of the index is attributed to data collection lags. As rental prices stabilize and more rental units become available, shelter inflation is projected to continue its deceleration trend in the coming months. The increased construction of multifamily units is identified as a key factor contributing to the slowdown in rent growth, reflecting a shift in the supply-demand dynamics of the rental market.
The complex interactions between housing inflation, shelter prices, and the CPI calculation methodology present challenges in accurately reflecting the true dynamics of the real estate market. While efforts are being made to align the shelter inflation index with current market trends, the inherent delays in data collection and processing continue to impact the timely adjustment of inflation readings. As policymakers and economists navigate these challenges, a deeper understanding of the intricacies of housing inflation is essential to formulate effective strategies to address inflationary pressures in the economy.