Owners' Equivalent Rent
Housing units are not in the CPI market basket. Like most other economic series, the CPI views housing units as capital (or investment) goods and not as consumption items. Spending to purchase and improve houses and other housing units is investment and not consumption. Shelter, the service the housing units provide, is the relevant consumption item for the CPI. The cost of shelter for renter occupied housing is rent. For an owner-occupied unit, the cost of shelter is the implicit rent that owner occupants would have to pay if they were renting their homes.
The expenditure weight in the CPI market basket for Owners’ equivalent rent of primary residence (OER) is based on the following question that the Consumer Expenditure Survey asks of consumers who own their primary residence: "If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”
A reader pointed out the BLS uses that question to determine the weight not the percentage, of OER in the CPI, something I had missed.
Nonetheless the question is absurd. Let's continue.
Price Change for OER and for Rent Using the sample of rental units, the CPI calculates a measure of price change for each CPI index area for the Rent index and for the OER index. The first step is standardizing the collected (market) rents, putting them on a monthly basis, and adjusting them for a number of circumstances that should not affect the CPI. These include adjusting for any changes to the structure, such as changes in the number of rooms or bathrooms or in the type of heating and cooling equipment, or changes in the number of pets. These standardized rents are called normalized rents.
In addition the CPI adjusts the rent for the effect of aging of the rental units over time. The Housing sample collects the rents from the same housing units every six months. Consequently, each time the CPI observes the rent of a sample unit it is six months older. To account for this aging, an age-bias factor is applied to the current rent; this raises the rent slightly because the older unit is slightly less desirable. For example, a unit with a rent of $900 might have the rent adjusted to $901.
The CPI assumes that sample units reported to be vacant are transitioning to new tenants. Experience with rent data has shown that units tend to experience rent change when the tenant changes. To avoid missing this rent change for vacant units, the CPI performs a class-mean imputation to estimate their rents.
The estimated current rent of a vacant unit is its previous rent times the average rent change of newly-occupied units. For example, if the average rent increase for new tenants in an area was 5 percent, a currently-vacant unit that rented six months earlier for $1000 would have a current estimated rent of $1050.
To calculate the relatives of change for the Owners’ equivalent rent index, the CPI calculates what it calls the pure rent from the normalized rent, removing the value of any utilities included in the rent. Owner-occupants pay for their own utilities and the CPI accounts for them outside of Shelter.
Thus, OER prices may be in the ballpark if you believe the above procedure is accurate, but the weight is determined by a ridiculous process.
Regardless, home prices are not in the CPI and they used to be. The BLS explains homes are a capital investment. OK fine.
Anyone with kids in college has their own set of problems.
What about medical expenses? A large percentage of people are sheltered from huge medical increases because their company picks up the tab. Those on Medicare or Medicaid see low increases.
But what is the true cost of medical service?
Anyone who buys their own insurance understands the cost has risen dramatically.
The BLS averages this all together and comes up with a ridiculously low number that anyone who buys their own insurance would laugh at.
Inflation vs CPI
Is it only inflation if the consumer pays for it?
The CPI purportedly measures consumer inflation. The problem is "consumer inflation" is a very poor measure of actual "price inflation".
It's inflation that matters, not alleged consumer inflation.
But the Fed, economists, and mainstream media all have their eyes on the CPI.