There is a three-letter acronym that economists have begun to pronounce with the power of a four-letter word: “OER.”
It stands for owner’s equivalent rent and is used to measure housing inflation in the US. since the 1980s. As the name suggests, it uses a combination of surveys and market data to estimate the cost to homeowners of renting their home.
But three years into America’s price boom, economists’ hatred of housing measures has become almost a cliché. detraction explosion if because the developments are so slow that they do not reflect updated economic conditions. Critic argumentative that it uses complex and meaningless statistical methods. The biggest haters insist that it gives the wrong impression where inflation stands.
“It doesn’t add anything to our understanding of inflation,” said Mark Zandi, chief economist at Moody’s Analytics and a frequent adviser to the Biden administration. Full disclosure: The New York Times called Mr. Zandi for this article because he is one of many economists grumbling about OER on social media. He said he was “not a fan.”
What did this strange inflation ingredient do to earn so much vitriol?
It is more or less hindering an economically happy ending. Measures of housing inflation have become surprisingly difficult over the past year and they are now a major barrier preventing overall price growth from returning to normal. That has a knock-on effect: Because of the staying power of inflation, the Federal Reserve is keeping interest rates at more than two-decade highs to try to control prices by slowing the economy.
But while there’s no denying that OER has become a major player in America’s inflation story, not everyone thinks it’s a villain. Some economists argue that it is a fair and reasonable way to measure an important part of the consumer experience. Ahead of the new Consumer Price Index report released Wednesday morning, there’s some important information to understand about how housing inflation is calculated, what it means and what it might do next.
OER attempts to measure the ‘consumption value’ of housing.
Let’s start with the basics. There are two main measures of inflation in the US: the Consumer Price Index and the Personal Consumption Expenditures index. Both are important: CPI is published earlier each month, providing a first overview of price developments over the past month. PCE appeared later but is the index that Fed officials aim for with an inflation target of 2%.
The two indices track slightly different concepts. The Consumer Price Index tries to capture what people spend their money on (i.e. what you’re spending), while the Personal Consumption Expenditure measure measures the cost of things like care health that your employer-provided insurance helps pay for (i.e., what you’re consuming).
Both are based on the same underlying housing data, but because of different calculations, housing make up much larger share of the Consumer Price Index: about 33 percent, compared with approx 15 percent for PCE
CPI’s huge housing share comes from two sources. “Prime rent” measures the amount of money people spend on rental housing and accounts for about 8% of the total inflation index. “Owner-equivalent rent” figures, which estimate the cost of renting an owner-occupied home, make up 25 percent is much larger.
You might be thinking: Why would the government use this complicated measure of housing when measuring house price growth would be simpler? The answer is that a home is an investment. Counting their price increases as “inflation” is like saying that an escalating stock market is “inflationary.”
But a home is more than just an investment. Housing is also something we consume, and by living in a home, the owner is giving up the financial opportunity to rent it out. So, to arrive at the “consumption value” of owning that house, the government tries to calculate how much it costs to rent it.
How we estimate that rent is a bit of a hassle.
The government uses essentially a two-step process to determine housing cost inflation. Step 1: Figure out how much the rent and owner-equivalent rents will index for inflation relative to everything else consumers buy. Step 2: Find out how much rents actually increase.
Step 1, weight, is based on two surveys Question: If you own, how much can you get if you rent out your house or apartment? And if you rent, how much do you pay?
Step 2, the price change, is based on actual rental data. The government collects data from a sample of rental housing units, checking each unit every six months to see whether landlords are charging extra fees. (It makes adjustments to these figures: For example, single-family homes have a greater weight in the owner-equity measure, because owned housing is more likely to is a house rather than an apartment.)
Combine the weighting with price changes and, hey, your housing has contributed to inflation. For housing, Consumer Price Index inflation reached 3.4% in April. Subtracting housing and recalculating the index accordingly, inflation would be around 2.3%.
Clearly, housing inflation is the main reason why inflation remains high.
We are still waiting… and waiting… for more cooling.
Economists are waiting for housing-induced inflation to decline more sharply. Market data provided by companies such as Zillow and data regarding new rental prices introduced by the government, they all show increased rental prices in new rental locations has cooled a lot in the past two years.
But the inflation index measures all housing, not just new rentals. As market rents skyrocketed in 2021, not all tenants immediately saw their rent reset to a higher rate: Landlords have gradually reset leases to higher rates, causing previous prices to gradually appear in official housing inflation data.
Forecasters expect the catch-up to end in 2023 and 2024, causing housing costs and overall inflation to decline significantly. But the convergence between new and existing rent inflation took longer than expected.
Economists still expect pass-through to occur, but they are increasingly less confident about how quickly and how much it will spread. And some people are anxiously watching some measures New apartment rental prices show signs of increasing again. The rent measure tracked by research firm Zelman & Associates is also showing early signs of renewed strength.
“If you asked me six months ago, I would have said: Yes, they will have to converge,” said Mark Franceski, chief executive officer at Zelman. “Every month that passes without them doing so, I become less confident.”
So does OER have a place in inflation?
Because today’s housing inflation is essentially catch-up inflation, some economists say we should ignore it. In Europe, some point to the main measure of inflation Does not include owner-occupied housing total.
But while this measure received a lot of heat because “fake” or “inflationist,” or based on frequency (but not exactness) assertive that it comes from a questionable survey, some economists side with it.
“Let me break up with the youth and defend OER,” said Ernie Tedeschi, who until recently was chief economist at the White House Council of Economic Advisers. “For one thing, it’s important to stick to the inflation index you started using,” he said. Moving the targets could undermine public confidence in the Fed’s commitment to fighting inflation.
Mr. Tedeschi also emphasized that OER tries to achieve an important idea. As housing values change over time, it shapes our economic lives.
For example, if a homeowner moves and needs to rent the home, it will be more expensive to do so. (Europe, for what it’s worth, Working develop an explicit measure of one’s own owner-occupied housing costs because it is an important component of inflation.)
Just as hard-to-measure forces in physics are important to how the universe works, Tedeschi said, the value we derive from where we live is vitally important to the world. economic performance – even if it is complicated.
“OER is kind of the dark matter of economics,” he said.
