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Over the past few years of inflation, sceptics have insisted that governments are underestimating price increases - usually without much evidence to back up their claims. But a new controversy in American economics has highlighted the problem of accurately measuring prices. Only this time the implications run in the opposite direction, suggesting that inflation may prove a more stubborn foe.
At issue is the way in which housing fits into the consumer price index. To the surprise of many casual observers, statisticians do not usually include house prices in their inflation indicators because they consider housing to be a capital good that buyers acquire perhaps once in a lifetime. However, statisticians know that housing is an important part of personal budgets and want to track regular changes in house prices, as they do for other consumer products. Therefore, instead of measuring house prices directly, their inflation indices take into account how much people pay for rent - or how much they would pay for rent if they were renting their own home. This is called the owners' equivalent rent (oer).
In America, the oer makes up about a quarter of the consumer price index, making it the single largest component. In contrast, direct rent makes up only 8 % of the index, because renting is less common: about two-thirds of American households own the houses in which they live. Estimating the value of rent is more difficult. It is not as simple as adding up all market rents and assuming that homeowners would pay the same. Rather, experts tend to give more weight to the rental prices of single-family homes that are similar to those that people own. The problem is that there are relatively few single-family homes for rent, so statisticians have a small sample to work with.
These complexities come to the fore in the context of growing concerns about persistent inflation in America. In January, the Consumer Price Index rose 0.3 % from the previous month, more than the 0.2 % rise expected, suggesting the Federal Reserve is struggling to tame inflation. However, almost half of the broader rise in inflation was accounted for by the oer growth itself. And it is striking that oer growth was much higher than market rent growth.
The question is whether the oer is estimated correctly. It is true that rents have recently been rising more in detached houses than in flats, reflecting the fact that there are few such houses for tenants. In addition, the Bureau of Labor Statistics, which compiles the Consumer Price Index, adjusted its methodology in January and increased the weight of detached single-family homes in the oer by about five percentage points as part of its ongoing effort to capture changes in housing patterns. The combination of higher rents and higher weights explains much of the increase in the oer index. However, this is compounded by the inevitable volatility in obtaining prices from a small sample of single-family rental homes. This raises the possibility that at least some of the high oer values were coincidental.
Nevertheless, the broader picture shows that rent inflation is significantly higher than net rent inflation (see chart). Continued stress in the single-family market ensures that this divergence is likely to continue for some time, and this in turn will put upward pressure on general measures of inflation. The details of calculating oer may seem complex. But the conclusion is clear: by feeding sticky inflation, it may well dissuade the Fed from cutting interest rates soon.¨
economist.com/gnews.cz-GeH_07
https://www.economist.com/finance-and-economics/2024/03/07/americas-rental-market-mystery
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