Shelter Prices Contribute to Consumer Inflation

Consumer prices faced by urban consumers nationwide, as measured by the Bureau of Labor Statistics’ Consumer Price Index – Urban Consumer (CPI), rose by 1.6 percent over the past year on a not seasonally adjusted dating back to June 2016. However, over the past month, consumer prices were unchanged (seasonally adjusted basis). The Shelter Price Index was a key contributor to the 12-month change in consumer prices overall because of its higher growth rate and because of its relative weight in the composition of the CPI. Two components of the Shelter Price Index, Rent of Primary Residence and Owners’ Equivalent Rent, both recorded increases over the year. These two categories measure the change in the shelter cost consumers receive from their primary residences”.

The figure above illustrates the major components of the CPI and their impact on growth over the year. This chart highlights the important role played by shelter prices in overall inflation. First, shelter prices represent the largest share of the CPI and is considered the largest expense faced by consumers. Second, the Shelter Price Index recorded one of the higher growth rates over the past year, relative to other categories of the CPI. As a result, its contribution to overall price growth is greatest.

The categories recording price declines over the past year were Commodities Less Food and Energy and Education and Communication Services. After excluding Energy and Food from the overall CPI, or “headline” CPI, the leftover portion, “core” CPI, is decomposed into Commodities and Services. Prices of Household Furnishings and Supplies, which declined by 1.3 percent over the past year, reside in this category. The decrease in the prices of education and communication services resulted from lower prices of wireless telephone services.

As previously mentioned, shelter prices are an important component of the CPI both because of its size and because of its rate of growth over the past year. One component of the Shelter Price Index is “Rent of Primary Residence”, which accounts for approximately 23 percent the Shelter Price Index and rose by 3.9 percent over the past 12 months. Since “rental prices” rose faster than overall inflation, even after adjusting the CPI for the more volatile food and energy prices (e.g. using core inflation), then “real” rental prices rose as well. NAHB’s Real Rent Index grew by 2.1 percent over the past year.

The Shelter Price Index, the largest component of the CPI, also includes “Owners’ Equivalent Rent of Primary Residences” (OER). The OER, which accounts for 69 percent of the Shelter Price Index and grew by 3.2 percent over the past year, captures the change in the shelter cost that homeowners receive from their primary residence. As a result, changes in the OER only capture a portion of changes in house prices generally because the rest of the home’s value reflects owners’ investment in the home as an asset*.

Since a home’s value reflects both its status as a stream of services that is consumed and as an investment, than comparing changes in the OER with changes in house prices overall can illustrate housing inflation’s contribution to changes in house prices overall. The figure above decomposes annual house price growth from S&P/Case-Shiller’s National House Price Index into housing inflation and housing asset price growth. The asset price growth is the difference between overall house price appreciation and housing inflation (change in the OER).

During the housing boom, house prices rose, largely reflecting increases and acceleration in the asset component of house prices. In contrast, housing inflation slowed to 2.3 percent by 2004 and 2005. Over the 2007 to 2010 period, house prices fell overall reflecting declines in the asset component of house price appreciation. Meanwhile housing inflation remained positive between 2007 and 2009, although it slowed to 0.0 percent by 2010. Since 2010, housing inflation has steadily accelerated while the asset component of house prices rose markedly in 2013, but slowed over 2014 and 2015, stabilizing in 2016.

* The BLS explains the OER component in the following manner: “The CPI is attempting to measure the changes in the Cost-of-Living for an average urban consumer, which addresses the following question: “What is the cost, at this month’s market prices, of achieving the standard of living actually attained in the base period?” This suggests that the CPI must only include the parts of owning a home that affect the standard of living. Hence, the investment portion of owning a house must be separated from the consumption portion, as represented by the service flows that are provided by owning the house.”

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