The owner's equivalent rent (OER) index has received a lot of press lately because it's primarily responsible for keeping reported inflation well above the Fed's 2% target. Yet, if asked, many analysts and even policymakers probably need to learn why OER exists.
OER is a concept unique to how housing units are accounted for in GDP statistics. In GDP, rental units and owner-occupied units are considered the same. To maintain this equivalence, an imputed estimate shows how much money owner-occupied units would have spent if they were renting to match the money tenants paid for housing. This process, which creates an artificial expenditure in consumer spending, necessitates the creation of a price measure or a deflator. That's because the government needs to estimate the imputed 'real' value of money owners spend for rent when calculating Real GDP.
OER is a 'fake price, a unique concept involving zero transactions. No one actually pays OER, and as a result, it does not generate any economic activity such as sales, income, or jobs. Therefore, official rate increases do not affect the demand associated with OER. However, despite its unique nature, it has accounted for a significant part of the increase in consumer price inflation in the last three years. For instance, the increase in shelter costs contributed to more than a third of the 3.4% rise in consumer prices in the past twelve months.
OER is suitable for GDP accounting, but why does the CPI use OER to measure housing costs? It's political because if housing costs were calculated based on house prices and borrowing costs, reported inflation would be much higher nowadays and would have run markedly higher for the past forty years.
BLS and the Fed should be humble enough to admit that, but they won't.
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