In 1983, the Bureau of Labor Statistics (BLS) made a change to an integral component of inflation indexes. The adoption of owners’ equivalent rent (OER) to estimate shelter costs meant home purchases would no longer be considered a consumption expenditure but instead a capital asset or investment. OER is determined by a monthly survey of consumers who own a primary residence. The survey asks how much consumers would pay to rent instead of own their home. OER represents approximately 25% of the Consumer Price Index and 12% of personal consumption expenditures (PCE).
This week’s chart highlights the stability of OER versus market-based measures of home prices during the past two decades. The stability of OER has undoubtedly reduced the volatility of monthly inflation readings and helped Federal Reserve (Fed) policymakers deliver one of their dual-mandate goals — stable prices.
Why has OER exhibited such stability versus market-based measures of shelter costs? Economists have observed that owner-occupied rental estimates tend to be “sticky” relative to market-based rental costs. Homeowners tend to underestimate rent appreciation during expansionary periods and overestimate it during recessionary periods. Research by the Cleveland Federal Reserve suggests the best predictor for OER inflation is recent OER inflation. In other words, OER momentum is a more useful predictor for future OER measures than home price appreciation, vacancy rates, interest rates or unemployment.
The idea that home purchase costs are not an expenditure but an investment is likely difficult to understand for first-time homebuyers confronted with unaffordable housing options. As Fed policymakers increasingly focus on more broad-based and inclusive policy goals, relying on OER for housing costs is likely masking the challenges that higher home prices pose for families and communities in the United States.
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