Overstating Inflation

It appears that the imputed rent, where a synthetic rent, Owner’s Equivalent Rent, is used by the BLS uses to compute its inflation figures which significantly overstates inflation. 

I know that the AIER is a right wing economic "Think" tank, but they are far from the only group in economics establishment that holds this position, including the even more inflation phobic European Central Bank, and this is a readable discussion of what is normally economic minutiae.

To be clear, this is not a deliberate deception.  It is a matter of economic philosophy trumping reality.

The Bureau of Labor Statistics measures changes in housing costs in ways that change slowly and arrive too late. Studies from the BLS, Federal Reserve Banks and prominent economists find lags of 12-18 months before changes in rents and/or house prices finally get reported as higher or lower housing inflation in CPI or PCE inflation reports.

CPI shelter (housing) consists of periodic surveys of old and new leases, so the old ones turn over slowly. Owner’s Equivalent Rent (OER) uses rent survey data to fabricate an inherently implausible average estimate of what millions of owned homes could have been rented for. OER alone is a fourth of the CPI, and OER plus rent means shelter accounts for 34 percent of the CPI and 42 percent of Core CPI.

A long data lag makes these overweighted housing inflation estimates so misleading the Fed Chairman Powell has warned against measuring inflation services without first removing housing. If we look at “CPI less shelter,” the average annual rate of inflation over the past ten months was 0.6 percent. And the producer price index (PPI) – which also excludes housing – rose at a similar 0.9 percent rate.

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Before that, from April 2021 to June 2022, CPI inflation averaged 8.6 percent. Getting inflation down from 8.6 percent to 3.3 percent belies the cliche about inflation being sticky or stubbornly high. Yet that 3.3 percent figure drops much further – to 0.6 percent – if we exclude shelter.

Why exclude shelter from the CPI? Because the numbers are wrong.

Energy prices in April were down 4.9 percent from a year earlier, but shelter prices were up 8.1 percent. The Fed and the Fed press corps want to remove food and energy from the CPI, but doing that makes shelter 42 percent of that shrunken “core” index. Yet energy prices really are much lower than a year ago, while home prices or rents are definitely not rising at an 8.1 percent rate as published CPI figures suggest. 

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Before that, lagged OER and rent understated inflation by nearly three percentage points from the time of the March 2021 stimulus checks to June 2022 – lowering apparent inflation with housing included to 8.8 percent from a non-housing rate of 11.5 percent. Lagged rent and OER held down reported inflation in 2021 to early 2022 because BLS estimates were then reflecting, with a lag, the soft housing market during the pandemic lockdowns from March 2020 to February 2021.  

Because OER alone is a fourth of the CPI, the easiest way to fix the huge data lag problem is to remove OER from our measures of inflation – as other countries do. The Bank of England does not include OER in its inflation target. The European Central Bank monitors the EU “harmonized index of consumer prices” (HICP) which excludes OER.

What would happen if the U.S. kept rent in the CPI but removed the much larger OER errors, as the EU does? Answer: The Harmonized Index of Consumer Prices for the United States rose at a 1.3 percent annual inflation rate from July 2022 to April 2023. 

If the Fed had been targeting the same sort of consumer price index that European central banks do, they could have stopped raising overnight interest rates on bank reserves long before the federal funds rate rose dangerously far above the yield on 10-year bonds. Keeping the yield curve inverted for six months risks a hard landing needlessly because, if we simply avoid being deceived by misleading OER and rent estimates, inflation has come down quite rapidly since last June.

OER has been problematic since it was introduced by the Reagan administration as a way to manipulate the numbers to their political benefit, much in the way that the The Clinton Administration "Hedonic Adjustments" to the CPI.

There has been a way to insulate the collection and distribution of government economic statistics from both politicians and economists.