Hopes that high inflation will be short-lived may be quashed by the recent run-up in home prices and rents.
That’s one of the main takeaways from a new working paper co-authored by former Treasury Secretary and Harvard economist Lawrence Summers. In the paper, Summers and his coauthors — independent researcher Judd Cramer and International Monetary Fund economist Marijn Bolhuis — explore the relationship between the housing inflation measures from the Consumer Price Index (CPI) and Personal Consumption Expenditure Price (PCE) Index reports and private-market gauges of home prices.
As the researchers note, housing inflation only amounted to around 4% for the 12 months ending in January. Comparatively, Zillow
reported that home values had risen by nearly 20% over that same period of time, while rents had increased by nearly 15%.
While the CPI and PCE reports weigh housing inflation differently, they both rely on the CPI housing data for their calculations, which the researchers said is often not the case. And the way that the government tracks housing inflation largely relies upon a “more backward-looking measure,” Summers and his coauthors wrote in the paper distributed by the National Bureau of Economic Research.
This is an argument other economists have made regarding the potential flaws in how the government tracks housing inflation. To calculate housing inflation for homeowners, the government uses a measure called “owners’ equivalent rent.” When the federal government surveys consumers to learn what they’re paying for goods and services, they ask homeowners to estimate what they could charge to rent their house, while renters are simply asked what they pay each month.
But, as Summers and his colleagues write, “Unlike milk, rent is not something a consumer encounters a price for daily.” Renters will typically only encounter an increase in rent when they renew a lease or move. Homeowners wouldn’t pay more on a monthly basis unless their mortgage rate adjusts higher or they buy a new home. And homeowners might be slow on the uptake vis-à-vis rising rental rates.
Plus, the different groups of consumers that the federal government surveys are only periodically asked about their housing expenses — meaning that it takes time for these price changes to be baked into the inflation measures.
Summers and his co-authors estimated that housing inflation would occur at a pace of roughly 6.5% to 7% in 2022, as measured by CPI and PCE. They came to this projection by comparing the past relationships between private-market measures of home prices and rents and movements in the government’s key inflation meters.
“The way that housing inflation is measured — as the average price growth across all housing occupants, not as the average price increase one looking for housing today would pay relative to an earlier period — ensures that past developments in the housing market will result in an increase in recorded housing inflation in 2022,” they wrote.
Furthermore, they expect that housing inflation will peak in the second half of this year, but remain elevated in 2023. Overall, they said the rise in housing costs will contribute to an increase of 2.6 percentage points for core CPI.
“We estimate housing’s contribution to 2022 inflation as almost incompatible with a swift return to trend inflation,” they said.