The Biggest Driver of Inflation Is a Price That No One Is Actually Paying

The most widely watched measure of inflation is being driven up by a measure of housing costs that no one is actually paying. 

The Consumer Price Index, the most-tracked way to measure the cost of living, rose 6% over the last year as of February, down from 6.4% in January, the Bureau of Labor Statistics said Tuesday. The 0.4% monthly increase in prices, down from 0.5% in January, was a sign that inflation, while receding, is still squeezing household budgets. 

Almost three-quarters of the monthly increase—some 70%—came from housing costs, and more specifically, a measure called Owners’ Equivalent Rent (OER), which rose by a record 8% over the year.

OER is by far the largest component of the Consumer Price Index, making up a quarter of its total value. The overall CPI measures most things a typical household pays for, from groceries to gas, to movie tickets and college tuition. Because the “basket” of prices measured is meant to be proportional to the costs people actually pay, housing costs loom large in the calculations. 

For most goods and services, the process of recording prices is relatively simple: The bureau sends someone to a store, or calls a business, to see what they are charging for a bag of rice or to send a plumber out to repair a leaky faucet. Recording housing prices isn't as straightforward. The bureau measures actual rental rates for houses, and, using that data, estimates how much owner-occupied houses would rent for if they were put on the market. 

“It's a little bit of a fuzzy metric,” said Ryan Sweet, chief U.S. economist at Oxford Economics.

OER is effectively the rent that the homeowner is giving up by living in their house instead of renting it out. It’s influenced by housing prices, but not directly tied to it.

“When house prices are rising, I'm going to rent my house for a higher price than if house prices were falling,” Sweet said. 

As a result of its methodology, the all-important OER measure tends to lag behind movements in nationwide home prices by about a year. It took a long time for the pandemic-era surge in home prices to show up in the Consumer Price Index, and it will likely take a long time for the recent cooling of the housing market to show up as well.

“As house prices declined modestly, nationally, we should see that component start to come down,” Sweet said. 

Housing costs play less of a role in the inflation measure preferred by officials at the Federal Reserve. The Personal Consumption Expenditures inflation rate, created by the Bureau of Economic Analysis, is less influenced by rent and home prices, (giving it about half the statistical weight the CPI does), and is the one the Fed uses when deciding whether inflation is running at the 2% annual goal.