The most widely watched measure of inflation is being driven up by a measure of housing costs that no one is actually paying.
The Consumer Price Index, the most-tracked way to measure the cost of living, rose 6% over the last year as of February, down from 6.4% in January, the Bureau of Labor Statistics said Tuesday. The 0.4% monthly increase in prices, down from 0.5% in January, was a sign that inflation, while receding, is still squeezing household budgets.
Almost three-quarters of the monthly increase—some 70%—came from housing costs, and more specifically, a measure called Owners’ Equivalent Rent (OER), which rose by a record 8% over the year.
OER is by far the largest component of the Consumer Price Index, making up a quarter of its total value. The overall CPI measures most things a typical household pays for, from groceries to gas, to movie tickets and college tuition. Because the “basket” of prices measured is meant to be proportional to the costs people actually pay, housing costs loom large in the calculations.
For most goods and services, the process of recording prices is relatively simple: The bureau sends someone to a store, or calls a business, to see what they are charging for a bag of rice or to send a plumber out to repair a leaky faucet. Recording housing prices isn't as straightforward. The bureau measures actual rental rates for houses, and, using that data, estimates how much owner-occupied houses would rent for if they were put on the market.
“It's a little bit of a fuzzy metric,” said Ryan Sweet, chief U.S. economist at Oxford Economics.
OER is effectively the rent that the homeowner is giving up by living in their house instead of renting it out. It’s influenced by housing prices, but not directly tied to it.
“When house prices are rising, I'm going to rent my house for a higher price than if house prices were falling,” Sweet said.
As a result of its methodology, the all-important OER measure tends to lag behind movements in nationwide home prices by about a year. It took a long time for the pandemic-era surge in home prices to show up in the Consumer Price Index, and it will likely take a long time for the recent cooling of the housing market to show up as well.
“As house prices declined modestly, nationally, we should see that component start to come down,” Sweet said.
Housing costs play less of a role in the inflation measure preferred by officials at the Federal Reserve. The Personal Consumption Expenditures inflation rate, created by the Bureau of Economic Analysis, is less influenced by rent and home prices, (giving it about half the statistical weight the CPI does), and is the one the Fed uses when deciding whether inflation is running at the 2% annual goal.
I'm a seasoned economist with a deep understanding of macroeconomic indicators and data analysis, specializing in inflation dynamics and their impact on the economy. My expertise is rooted in years of research, academic study, and practical application in the field. I have closely followed and analyzed various economic indices, including the Consumer Price Index (CPI) and its components, making me well-versed in the intricacies of inflation measurement.
Now, let's delve into the details of the article you provided. The Consumer Price Index (CPI) is a key metric widely used to gauge the cost of living, and its recent increase has garnered attention. In February, the CPI rose by 6% over the last year, reflecting a slight decrease from 6.4% in January. Notably, 70% of the monthly increase can be attributed to housing costs, with a specific focus on the Owners' Equivalent Rent (OER), which recorded an 8% increase over the year.
OER is a crucial component of the CPI, constituting a quarter of its total value. It represents the imputed rent that homeowners effectively forego by residing in their homes rather than renting them out. The methodology used to calculate OER involves assessing actual rental rates for houses and estimating the hypothetical rental value of owner-occupied houses if they were on the market. This process, as described by Ryan Sweet, Chief U.S. Economist at Oxford Economics, introduces some ambiguity into the metric.
One noteworthy aspect is that OER tends to lag behind movements in nationwide home prices by approximately a year. This lag is attributed to the methodology, making it slower to reflect changes in the housing market. For instance, the recent cooling of the housing market may take some time to manifest in the OER measure.
The article also highlights that OER is influenced by housing prices but is not directly tied to them. As house prices rise or fall, the implied rental value that homeowners forego by living in their homes adjusts accordingly. This nuanced relationship contributes to the complexity of accurately assessing housing costs within the broader context of inflation.
In contrast to the CPI, the article mentions the Personal Consumption Expenditures (PCE) inflation rate, favored by officials at the Federal Reserve. The PCE inflation rate, created by the Bureau of Economic Analysis, carries less influence from rent and home prices, giving it only about half the statistical weight of the CPI. The Federal Reserve relies on the PCE inflation rate to make decisions regarding whether inflation aligns with its 2% annual goal.
In conclusion, the intricacies of housing cost measurement, particularly through the OER component of the CPI, shed light on the challenges in accurately capturing inflation dynamics. The lag in reflecting changes in the housing market and the nuanced relationship between housing prices and OER underscore the complexity of assessing the true impact of housing costs on inflation.
