Housing inflation has been a persistent issue afflicting the U.S. economy, even as overall inflation rates have shown signs of declining post the peak levels witnessed during the pandemic era. The sluggish decrease in housing inflation has been a major hurdle in achieving the targeted consumer price index, as noted by economists. This phenomenon is primarily attributed to the fact that housing constitutes a substantial 36% of the CPI index, making it the largest contributor compared to other categories like food and energy. The sheer magnitude of housing expenses for the average household underscores the significant impact that movements in shelter prices have on inflation metrics.
Shelter inflation serves as a crucial metric for gauging rental prices in the U.S. market. However, the calculation methodology adopted by the Bureau of Labor Statistics results in a lag in the shelter inflation index relative to real-time rental market trends. Despite the slow decline in shelter inflation, from a peak of about 8% in early 2023 to 5.2% in June 2024, the current levels still remain significantly higher than the pre-pandemic baseline. The lingering pace of the decline in shelter inflation has been slower than anticipated by experts, highlighting the discrepancy between the actual rental market conditions and the reflected data.
One of the reasons behind the delayed adjustment in the CPI data for shelter inflation is the intricate construction of the housing inflation index by the federal government. This methodological approach leads to significant delays in reflecting changes in shelter CPI readings compared to the prevailing rental market conditions. Federal Reserve Chair Jerome Powell acknowledged the presence of substantial lags in the shelter CPI data, indicating that it might take several years for these readings to align with the recent dynamics in the rental market. The two primary components of the shelter inflation index, rent, and “owners’ equivalent rent of residences,” play a pivotal role in determining the average housing costs in the U.S. economy.
While assessing the spending changes for renters is relatively straightforward, homeowners present a more complicated scenario due to the BLS categorizing owned housing units as investments rather than consumable goods. The inclusion of regular costs incurred by homeowners, such as mortgage payments, property taxes, and maintenance expenses, under the “capital” costs category complicates the calculation of CPI. The adoption of the “owners’ equivalent rent” category aims to standardize the comparison between renters and homeowners, by estimating the rental value that homeowners could have obtained by renting out their property.
The BLS has employed the framework of imputing rental values to owned homes since 1987, aligning with international practices in measuring inflation. The construction of the CPI shelter index involves sampling a staggered panel of renters and homeowners every six months, to capture the price changes effectively. This staggered approach leads to a gradual movement of the shelter index with a lag, reflecting past trends rather than current market conditions. The delayed response of the shelter inflation index to evolving rental market dynamics poses challenges in accurately depicting the inflation scenario.
Experts anticipate that shelter inflation will continue to moderate as it catches up with the trends observed in new rental contracts. The shift towards increased availability of rental units is expected to contribute to the deceleration in rental price growth. The surge in rental prices during the pandemic, driven by demand surpassing supply, is gradually subsiding due to the construction of more multifamily units. The ongoing trend of slowing rent growth underscores the evolving dynamics of the housing market and its repercussions on inflation metrics.