Housing inflation in the US economy has proven to be a stubborn issue, persisting at high levels even as other areas of inflation have cooled significantly post-pandemic. The slow decline in housing inflation has been identified as a major factor hindering the consumer price index from reaching policymakers’ target levels. According to Joe Seydl, a senior markets economist at J.P. Morgan Private Bank, housing constitutes a significant portion of the CPI index, making up 36% of the overall index. This large share is primarily due to housing being the most substantial expense for the average household, overshadowing other categories like food and energy. The movement of shelter prices holds considerable sway over inflation readings in the economy. Despite being a measure of US rental prices, shelter inflation index lags behind real-time rental market trends, as outlined by Jessica Lautz, deputy chief economist at the National Association of Realtors. The gradual pullback in shelter inflation has surprised economists, as it has been slower than anticipated. While it has decreased from around 8% to 5.2% annually in June 2024, it still remains considerably above the pre-pandemic baseline by 2 percentage points.
The Complexity of Shelter Inflation Index
Although the annual inflation rate for new rental contracts has plummeted to 0.4% in the first quarter of the year, significantly lower than pre-pandemic levels, the glacial pace of shelter inflation in the CPI data contrasts with the current state of the rental market. The primary reason for the delay lies in the methodology employed by the federal government to construct its housing inflation index, as outlined by economists. Federal Reserve Chair Jerome Powell highlighted the significant lags in shelter CPI readings, noting that it could take several years for the index to reflect the recent dynamics in the rental market. The shelter inflation index aims to gauge the average housing cost in the US economy, pivoting around two main components: rent and “owners’ equivalent rent of residences.” Homeownership complicates the assessment, as regular costs incurred by homeowners are predominantly treated as “capital” costs rather than consumption expenses in the CPI basket. The BLS uses the “owners’ equivalent rent” category to bridge the gap between homeowners and renters, aiming to put both on a level playing field. This methodology has been in place since 1987 and is widely adopted by many countries globally to evaluate inflation trends.
The Staggered Panel Approach
To construct the CPI shelter index, the government utilizes a “staggered panel” method, where a sample of renters and homeowners is surveyed every six months, ensuring representation across different groups. This sampling technique, although comprehensive, leads to a slow and lagging movement in the overall shelter index, as noted by economists. The gradual nature of the data collection means that what is reflected in the CPI data has already occurred in the preceding nine to twelve months, leading to a delayed response to the real-time rental market. Experts anticipate that shelter inflation will continue to moderate and align with trends in new rental contracts, particularly as more rental units become available in the market. This increased availability of rental units is expected to dampen rental price growth, which surged during the pandemic due to heightened demand surpassing supply constraints. Jessica Lautz emphasizes that the slowdown in rent growth can be attributed to the construction of more multifamily units in response to the increased demand, thereby balancing the rental market dynamics.
Overall, the analysis of housing inflation trends in the US economy reveals a complex interplay between the shelter inflation index, rental market dynamics, and homeownership nuances. While the slow decline of housing inflation poses challenges for policymakers and economists alike, a nuanced understanding of the intricacies involved can provide valuable insights into shaping future policy decisions and forecasting inflation trends accurately.
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