How the Housing Market Affects Inflation Nationwide

What Kind of an Impact Does Housing Have on Measures of Inflation?

Explaining the Shelter Index, OER, and More!

The battle against inflation is far from over, as the Federal Reserve is still measuring whether its rate hikes have done enough to effectively tame inflation, and bring it down to its 2% goal. We’ll cover whether the Fed will decide to increase rates again, or whether they will decide to pause their rate hikes in another post down the line. Today, we’ll be discussing how the housing market factors into the measurement of inflation, and why the housing market is one of the last dominos to potentially fall on the road to the 2% inflation goal.

Curious to see how this market has affected your home's value?  Find out how much your home is worth here.

How Does the Housing Market Impact Inflation?

The Fed measures inflation through several key inflation indicators, including the Consumer Price Index, or CPI. One of the primary contributors to that CPI, is the shelter component. Last month, according to the Bureau of Labor Statistics, which releases the CPI, the shelter index was the largest contributor to the CPI, remaining at the same level as it was in August, instead of potentially decreasing month over month. Overall, the shelter index accounted for over half of the monthly increase in inflation measured in the CPI. EY’s chief economist, Gregory Daco, said that the shelter increase was, “larger than expected”, and that, “It’s a category that I would expect and I still expect to show more disinflationary momentum”.

The CPI as a whole is broken up into 8 major categories.

  • Food and Beverages
  • Housing
  • Apparel
  • Transportation
  • Medical Care
  • Recreation
  • Education and Communication
  • Other Goods and Services

The core CPI, discounting the relatively volatile prices of food and energy, is a good indicator of underlying core inflation, according to the Bureau of Labor Statistics website.

What Components Make Up the Shelter Index of the CPI

Now that we’ve established what the CPI is, and how the shelter component has impacted the latest measurement, we can discuss what actually makes up the shelter index of the CPI. Referencing the BLS website, the shelter index is largely made up of owners’ equivalent rent of residences (OER), and rent of primary residence. Additionally, lodging away from home, and tenants’ and household insurance also contribute in small part to the shelter index. Put simply, owners’ equivalent rent is a measure of what homeowners estimate that their properties would rent for, unfurnished, and without utilities, according to Investopedia. The BLS uses this as a measure to gauge the real estate market, along with factoring in the rent of primary residence to calculate the shelter index of the CPI. OER is commonly linked to inflation, as the shelter index and OER are largely affected by home price changes, interest rates, property taxes, and other broader economic factors.

An Interesting Effect of the Fed's Battle Against Inflation

As mentioned above, a large contributor to the measurement of OER is home prices nationwide. Nationwide, however, home prices have remained elevated, as mortgage rates have kept many potential home sellers from listing their homes on the market, causing the prices of homes on the market to stay at an increased level. While the Fed’s benchmark interest rate does not directly affect mortgage rates, it does directly affect the lending institutions that provide mortgages nationwide. This means that the Fed, as a byproduct of their attempt to tame inflation by raising their benchmark interest rate, has partially contributed to the increase in the shelter component of the CPI, a measure of their success in battling inflation. Lawrence Yun, chief economist at the National Association of Realtors, said in a July news release that, “It is critical to expand supply as much as possible to widen access to home buying for more Americans. Home prices will be influenced by how much inventory is brought to the market”.

Want to see what homes are currently on the market?  Seach for current available here. 

Shelter Index Outlook Moving Forward

Thankfully, however, there is light at the end of the tunnel as far as the battle against inflation is concerned. Rent growth has had a steep deceleration since the middle of last year, and grew at only a 0.1% rate in September, compared to a 9% increase just the year before. Daco noted when talking to Yahoo Finance that he was encouraged when looking at the shelter index of the CPI, noting that, “I expect that category will show more disinflationary momentum in the coming months given what we’ve seen in real time”.

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