One significant but often misunderstood driver of inflation in the United States is a cost that most Americans do not directly bear. This cost is known as owners’ equivalent rent (OER), a measure designed to estimate what homeowners might charge if they were to rent out their own homes. Despite its importance in inflation calculations, OER can distort perceptions of inflation, given that the majority of American homeowners are not renting their properties.
OER plays a pivotal role in the Consumer Price Index (CPI), the primary gauge of inflation used by the government. It constitutes over a quarter of the CPI, significantly influencing the overall inflation rate. In May, for example, OER rose by 0.4%, making shelter costs the largest contributor to the month’s CPI reading, excluding food and energy. This persistent elevation in OER has kept the CPI high even as other inflation components have cooled down.
This metric’s influence is also notable in the Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditures Price (PCE) index, though to a lesser extent. The latest PCE data is anticipated to be released this Friday, shedding more light on the current inflation trends.
The Calculation of OER
The methodology behind OER involves asking homeowners in the Consumer Expenditure Survey to estimate how much they believe their home would rent for monthly if it were unfurnished and without utilities. This method ties OER closely to the rental market, where high rents can drive up OER estimates.
However, this component can be misleading because it does not reflect the actual costs most Americans face. The US is predominantly a nation of homeowners, with a homeownership rate of 65.6% as of the first quarter. Furthermore, a substantial portion of homeowners—nearly 40% or about 33.3 million people—do not have a monthly mortgage payment because they have paid off their loans. Among those with mortgages, many have fixed payments that do not fluctuate annually, and a significant number refinanced during the pandemic to take advantage of lower interest rates, reducing their monthly payments further.
As Dean Baker, senior economist at the Center for Economic and Policy Research, highlights, OER represents “a payment that literally no one is making.” This discrepancy means that while OER can elevate inflation statistics, it does not necessarily reflect the inflationary pressures experienced by most Americans. Consequently, the public’s perception of inflation might be skewed, contributing to widespread economic pessimism.
The Real-World Implications of OER
To illustrate, consider a homeowner who previously paid a $1,510 mortgage plus maintenance for a total of $2,600 per month on a Manhattan co-op. If asked to estimate the rental value of their apartment, they might say $3,500 a month, based on current market rates. This estimation would inflate the OER, even though the actual mortgage cost was significantly lower.
For newer homeowners, the picture is different. Those who purchased homes in 2022 and 2023 face higher monthly mortgage payments, averaging $2,100 according to Federal Reserve data. This contrasts with $1,400 per month for those who bought homes earlier. However, these newer homeowners represent a small fraction of the total homeowner population.
The Federal Reserve’s Perspective
Federal Reserve Chair Jerome Powell acknowledges the challenges posed by OER in inflation measurements. Despite these challenges, the Fed is not planning to adjust the use of OER in its calculations. Powell noted that this approach is consistent with international practices and remains an integral part of inflation metrics.
Dean Baker supports the Fed’s position but emphasizes the importance of contextualizing OER when discussing inflation. He suggests that stripping out OER from inflation metrics could present a more accurate picture of the inflationary pressures that Americans actually face. According to Baker, without OER, inflation rates would be closer to the Fed’s 2% target. This distinction could help the public better understand the actual economic environment and reduce the pervasive negativity about the economy.
Conclusion
Owners’ equivalent rent is a significant component of inflation calculations, yet it does not represent a direct cost for most Americans. Understanding the impact and methodology of OER can provide a clearer picture of inflation and its effects on the economy. As inflation remains a critical issue, accurately communicating these nuances is essential for informed public perception and policy-making.
