The Hidden Driver of Inflation: Understanding Owners' Equivalent Rent
Numerous factors influence the complex phenomenon of inflation. Owners' equivalent rent (OER) is a significant, yet often overlooked, driver of inflation. This component of shelter costs attempts to estimate what homeowners could hypothetically charge to rent their own properties. Despite its prominence in inflation metrics, OER can be misleading and may distort how everyday Americans perceive inflation.
What is Owners' Equivalent Rent?
The Bureau of Labour Statistics (BLS) uses the concept of owners' equivalent rent to account for homeowners' housing costs in the Consumer Price Index (CPI). Instead of considering actual mortgage payments, OER estimates the rent homeowners would pay if they were renting their own homes. Although this measure aims to offer a more comprehensive view of housing costs, it presents a distinct set of challenges.
The Disconnect Between OER and Reality
A significant issue with OER is that it does not reflect the actual financial experiences of most American homeowners who do not rent their homes. This discrepancy can create a gap between official inflation statistics and public perception. Dean Baker, senior economist at the Centre for Economic and Policy Research, highlights this issue: "When people see really high inflation, this is a component they do not see. If people are feeling bad about inflation, and if a large chunk of that is OER, it doesn't make sense."
OER is particularly influential because it accounts for more than a fourth of the CPI, one of the government's primary gauges of inflation. This means that fluctuations in OER can significantly impact the overall inflation rate, even if they do not directly affect the wallets of many Americans.
The Impact of OER on Inflation Perception
OER plays a significant role in keeping inflation high. In May, for example, OER increased by 0.4%, making shelter costs the largest contributor to that month's CPI reading, excluding food and energy costs. This persistent increase in shelter costs, driven in part by OER, means that even as other components of inflation cool, the overall index remains high.
For the average American, this can be confusing and frustrating. They might see headlines about persistent inflation and feel the economic pinch, but they do not directly relate to the housing costs driving these numbers. This disconnect can contribute to a negative perception of the economy, as people feel the burden of inflation without a clear understanding of its sources.
The Broader Implications
Understanding the impact of OER on inflation is crucial for both policymakers and the public. For policymakers, it highlights the importance of considering how inflation measures align with real-world experiences. For the public, it underscores the need for a more nuanced view of inflation that goes beyond headline figures.
Efforts to combat inflation need to take into account the specific components driving the increase. While traditional measures like adjusting interest rates can help, addressing the underlying factors, such as housing costs, requires targeted interventions. These might include policies aimed at increasing housing supply, stabilising rent prices, or providing more direct support to homeowners and renters.
The conclusion
Owners' equivalent rent is a significant, yet often misunderstood, driver of inflation. Its impact on the CPI can skew perceptions of economic health and contribute to public dissatisfaction. By shedding light on this component of shelter costs, we can foster a better understanding of inflation and work towards more effective solutions. As we continue to navigate the complexities of the economy, recognising the role of OER will be essential in crafting policies that truly reflect the financial realities of American households.