What’s Up in Inflation? Shelter and OER
The Consumer Price Index (CPI) increased 0.1 percent from December to January according to the Bureau of Labor Statistics (BLS). Cold weather across the country contributed to the increase in the CPI, as the electricity and natural gas components of the index both rose sharply. But more generally, an important factor behind recent inflation readings has been an upward trend in inflation in the shelter component of the CPI.
Shelter inflation is now the highest it has been since January 2008, based on annualized three-month growth rates to help smooth the data. Lodging away from home gave a boost to shelter inflation in January, but lodging away from home is pretty volatile over short time spans. A bigger driver of the trend in shelter inflation has been a run-up coming from owners’ equivalent rent of residences (OER). Over the last few months, OER inflation has also been at its highest levels since the beginning of 2008.
Interestingly, the recent trend in OER has diverged from the trend in rent of primary residences. Inflation in rents has been moving sideways since mid-2011, while OER has trended up since the start of 2013.
These two rental measures tend to move together over a very long time horizon. But there are important conceptual differences between the series that can explain both short-term and longer-lasting divergences. To construct the OER and rent of primary residences indexes, the BLS samples a single set of rental units. It then adjusts the sample weights for those units according to their shares in either the owner-occupied or rental market. But the universes of rental and owner-occupied housing naturally differ—think single-family owner-occupied houses versus large multifamily apartment complexes—and the changes in their rents or implied rents differ as well. In addition, the treatment of utilities differs depending on whether utilities are included in rents or not, because owners pay for their own utilities and the BLS measures utility prices separately. (The BLS provides excellent resources to explain the differences in rent of primary residences and OER; for example, see this pamphlet.)
Changes in OER have a significant impact on aggregate inflation as measured by the CPI. Shelter accounts for 32 percent of the CPI basket, and OER accounts for about three-fourths of the shelter index, or nearly one-fourth of the total CPI basket. (The other two main components of the shelter index are rent of primary residences, which accounts for 7 percent of the total basket, and lodging away from home, which makes up less than 1 percent of the total basket.) By far, OER has the largest relative weight of a single component in the CPI.
The story is slightly different for inflation statistics based on the Personal Consumption Expenditures (PCE) price index, where the equivalent concept to OER is called imputed rent. Imputed rent only accounts for 11 percent of PCE. With this smaller weight, movements in the OER equivalent play a smaller role in PCE inflation than they do in CPI inflation. Instead, health care services receive more weight in the PCE, accounting for 17 percent of the total basket, more than housing services’ combined 15 percent share. (Lodging away from home is not included in housing services in the PCE.) The reversal of the relative importance of housing and health care is one notable difference between the CPI and the PCE price index.
When food and energy prices are removed from the mix in the core CPI, OER has an even larger impact on inflation than it does on the all-items index: OER is 31 percent of the core CPI index. But year-over-year core CPI inflation was 1.6 percent in January, little different from its readings through most of 2013. Thus, the recent upward trend in OER inflation has been offset by other components in the core CPI.
How does this recent upward trend in OER inflation affect alternative measures of underlying inflation, such as the Cleveland Fed’s median CPI? Year-over-year inflation in the median CPI was 2.0 percent in January, not much different from where it has been through most of 2012 and 2013. So the upward trend in OER inflation has not pushed up the median CPI. This is somewhat surprising. Because OER has such a large weight in the total index, it is split into four regional subindexes when computing the median CPI; without this adjustment, the large weight of OER would usually cause it to be “the” median component. Nevertheless, even with this adjustment, one of the four OER regional subindexes is typically the median component (see this page for more detail).
Because both the core CPI and the median CPI are heavily influenced by OER, what would happen if we removed all four regional OER subindexes from the calculation of the median CPI? Doing so, we find that inflation in the median CPI excluding OER peaked in early 2012 and has been on a downward trend since then. In January, the median CPI excluding OER was 1.6 percent, significantly lower than the normal median CPI inflation measure but virtually identical to core CPI inflation. While the last few median CPI excluding OER readings have leveled off, we will have to see some additional data before we can call this a new trend.