Despite inflation in the overall economy showing signs of cooling down, housing inflation remains alarmingly high in the United States. This slow decline is proving to be a major obstacle in bringing the consumer price index back to desired levels, according to economists. Housing, which accounts for a significant 36% of the CPI index, has a massive impact on inflation readings due to its status as the most significant expense for the average household. The lagging trend in shelter prices is particularly concerning, with the inflation rate being slow to retreat from its peak levels.
Shelter inflation, which is essentially a gauge of U.S. rental prices, plays a crucial role in shaping inflation metrics. However, the calculation methodology employed by the Bureau of Labor Statistics (BLS) in determining these prices results in the shelter inflation index trailing behind real-time rental market trends. Despite hopes for a swift decline in shelter inflation, the reality paints a different picture. The drop to a 5.2% annual rate in June 2024 from a peak of 8% in early 2023 still leaves the index 2 percentage points above its pre-pandemic levels.
The sluggish pace of changes in the shelter portion of the CPI data can be largely attributed to the construction of the housing inflation index by the federal government. According to economists, shifts in shelter CPI readings are substantially delayed compared to the current rental market scenario. This delay has raised concerns, with Federal Reserve Chair Jerome Powell acknowledging the significant lag in reflections of rental market dynamics. The government’s approach to housing inflation indexing is based on assessing the average cost of housing in the U.S., comprising rent and owners’ equivalent rent of residences.
While renters’ spending patterns are relatively straightforward, the BLS faces challenges in evaluating homeowners’ expenses. The classification of owned housing units as investments rather than consumable goods complicates the calculation process. Regular costs associated with homeownership fall under capital expenses rather than consumption expenses, making it difficult to fit them within the CPI framework. The concept of owners’ equivalent rent aims to level the playing field between renters and homeowners, providing a rental value to owned homes for inflation assessment purposes.
The staggered panel sampling approach adopted by the government to construct the CPI shelter index results in a slow and delayed movement of the index. By surveying groups of renters and homeowners on a semi-annual basis, the government aggregates price changes to reflect the overall shelter index. As a result, the CPI data tends to reflect changes that have already occurred in the nine to twelve months leading up to the reporting period. Experts predict that shelter inflation will continue to moderate as it catches up with new rental contract trends and an increase in rental unit availability.
The ongoing deceleration in rental price growth is expected to persist as more rental units become available, countering the previous surge in prices driven by high demand and limited supply during the pandemic. The slowdown in rent growth is partially attributed to the increased construction of multifamily units, which has alleviated some of the pressure on rental prices. Despite the complexities surrounding the measurement of housing inflation, economists remain optimistic about the potential for a more balanced rental market in the future.
The puzzling trend of housing inflation in the U.S. economy continues to pose challenges for policymakers and economists alike. The slow decline in shelter prices and the delayed reflection of rental market dynamics in CPI data raise concerns about the accuracy of inflation readings. As the government grapples with finding a balance between renters and homeowners in inflation calculations, the future outlook remains uncertain but hopeful for a more stabilized housing market.