Housing inflation in the United States has been a persistent issue, remaining high even as the broader economy has shown signs of cooling off from the peak levels experienced during the pandemic. This slow decline in housing inflation has become a significant barrier to achieving the desired target for the Consumer Price Index (CPI), according to economists. With housing accounting for a substantial 36% of the CPI index, it holds a significant sway over inflation metrics due to being the largest expense for the average household.
Shelter prices, which are a crucial component of housing inflation, have a disproportionate impact on inflation readings due to their weight in the CPI index. While shelter inflation is essentially a measure of U.S. rental prices, the methodological approach taken by the Bureau of Labor Statistics in calculating these prices results in a lag between the real-time rental market trends and the shelter inflation index.
The Lag in Shelter Inflation
Despite expectations for a quicker decline, shelter inflation has been slow to retreat, with the annual rate dropping to 5.2% in June 2024 from a peak of around 8% in early 2023. The current level still remains 2 percentage points above its pre-pandemic baseline, leading economists to remark on the sluggish pace of improvement in this area. Olivia Cross from Capital Economics noted that the movement in shelter prices, while in the right direction, is far slower than initially anticipated.
One of the key reasons for the delayed reflection of changes in the rental market in CPI data is the methodology employed by the federal government in constructing the housing inflation index. With a focus on the average cost of housing in the U.S., the index comprises rent and “owners’ equivalent rent of residences” as its primary components. However, for homeowners, the calculation becomes more complex due to the classification of owned housing units as investments rather than consumable goods.
The Role of Owners’ Equivalent Rent
To bridge the gap between renters and homeowners in the inflation calculation, the BLS uses the concept of “owners’ equivalent rent” (OER), which assigns a rental value to owned homes based on what a homeowner could potentially earn from renting out their property. This approach, in use since 1987, aims to level the playing field between renters and homeowners within the CPI framework, though it does face criticisms for its limitations in capturing the true costs incurred by homeowners.
The Slow Movement of the CPI Shelter Index
Due to the methodical approach taken by the government in sampling data for the CPI shelter index, changes are somewhat delayed and gradual, leading to a lag in reflecting real-time market dynamics. As the government polls a staggered panel of renters and homeowners every six months, the aggregated data results in a slow-moving index that may not capture the most recent trends accurately. This lag has implications for understanding inflation and making policy decisions based on this data.
Experts believe that shelter inflation should continue to moderate as it catches up to the trends seen in new rental contracts and the increasing availability of rental units in the market. With rental prices seeing a surge during the pandemic due to demand exceeding supply, the subsequent slowdown in rent growth is attributed to the expansion of multifamily units being constructed. As more rental units become available, the pressure on rental prices is expected to ease, leading to a more balanced housing market.
The slow-moving nature of housing inflation and the intricacies involved in calculating shelter prices highlight the complexities of understanding and predicting inflation trends. While the lag in shelter inflation data poses challenges for policymakers and analysts, a nuanced approach to assessing real estate market dynamics is essential to making informed decisions about economic policies and interventions.
Leave a Reply