There’s a three-letter abbreviation that economists have started pronouncing with the energy of a four-letter word: “O.E.R.”
It stands for owner’s equivalent rent, and it has been used to measure American housing inflation since the 1980s. As its name suggests, it uses a combination of surveys and market data to estimate how much it would cost homeowners to rent the house they live in.
But three years into America’s price pop, it has become almost cliché for economists to hate on the housing measure. Detractors blast if for being so slow-moving that it does not reflect up-to-date conditions in the economy. Critics argue that it uses convoluted statistical methods that make little sense. The most intense haters insist that it is giving a false impression about where inflation stands.
“It’s just not adding anything to our understanding of inflation,” said Mark Zandi, chief economist of Moody’s Analytics and a frequent adviser to the Biden administration. Full disclosure: The New York Times called Mr. Zandi for this article because he has been one of the many economists grousing about O.E.R. on social media. He said he was “not a fan.”
What has this one nerdy inflation component done to earn so much vitriol?
It is preventing an economic happy ending, more or less. Housing inflation measures have been surprisingly sticky over the past year, and they are now a major barrier keeping price increases overall from returning to normal. That has knock-on effects: Because of inflation’s staying power, the Federal Reserve is keeping interest rates at a more than two-decade high to try to wrestle prices under control by slowing the economy.
But while there’s no denying that O.E.R. has become a main character in America’s inflationary tale, not everyone thinks it is the bad guy. Some economists think it is a valid and reasonable way to measure an important part of the consumer experience. Ahead of a fresh Consumer Price Index report set for release on Wednesday morning, there are a few key facts to understand about how housing inflation is calculated, what it means and what it might do next.
O.E.R. tries to measure housing ‘consumption value.’
Let’s start with the basics. There are two main measures of inflation in America, the Consumer Price Index and the Personal Consumption Expenditures index. Both matter: C.P.I. is released earlier each month, providing the first snapshot of what prices have done over the past month. P.C.E. comes later, but it is the index that the Fed officials aim for with their 2 percent inflation goal.
The two indexes track slightly different concepts. The Consumer Price Index tries to capture what people are buying out of pocket (i.e., what you’re spending), whereas the Personal Consumption Expenditures measure captures the cost of things like medical care that employer-provided insurance helps to pay for (i.e., what you’re consuming).
Both draw on the same underlying housing data, but because of their different calculations, housing makes up a much bigger chunk of the Consumer Price Index: about 33 percent, versus about 15 percent for the P.C.E.
The C.P.I.’s hefty housing portion comes from two sources. “Rent of primary residence” measures how much people are spending on rental housing and accounts for about 8 percent of the total inflation index. The “owner’s equivalent rent” metric, the one that estimates the rental cost of owned housing, makes up a much larger 25 percent.
You might be thinking: Why is the government using this convoluted housing measure when it would be simpler to just measure home price appreciation? The answer is that houses are an investment. Counting their price increases as “inflation” would be akin to saying a climbing stock market is “inflation.”
But homes are not just an investment. Housing is also something we consume, and by living in a house, an owner is forgoing the financial opportunity of leasing it out. So to get at the “consumption value” of owning that house, the government tries to figure out how much it would cost to rent it.
How we estimate that rent is a little wonky.
The government uses what is essentially a two-step process for determining housing cost inflation. Step 1: Figure out how much weight rent and owner’s equivalent rent should get in the inflation index versus everything else consumers buy. Step 2: Figure out how much rents are actually increasing.
Step 1, the weight, is based on two survey questions: If you own, how much could you get if you rented out your house or apartment? And if you rent, how much do you pay?
Step 2, the change in price, is based on actual rental data. The government collects data from a rolling sample of rental housing units, checking in on each unit every six months to see if the landlord is charging more. (It makes adjustments to these figures: For instance, single-family houses carry more weight in the owner’s equivalent measure, since owned housing is more likely to be a home versus an apartment.)
Combine the weight with the price change and, bam, you have your housing contribution to inflation. With housing, Consumer Price Index inflation totaled 3.5 percent in March. Subtract housing and re-weight the index accordingly, and inflation would have been something like 2.4 percent that month.
Clearly, housing inflation is a major reason inflation remains elevated.
We’re still waiting … and waiting … for more cooling.
Economists have been waiting for housing-fueled inflation to fade more sharply. Market data produced by companies like Zillow and data on new rentals produced by the government both show that rent increases on newly leased places have cooled a lot over the past two years.
But inflation indexes measure all housing, not just the newly rented places. When market rent prices jumped in 2021, not all tenants immediately saw their rents reset to higher levels: Landlords have gradually reset leases to higher prices, causing that earlier pop to slowly show up in official housing inflation data.
Forecasters thought the catch-up process would peter out in 2023 and 2024, allowing housing costs and overall inflation to come down notably. But the convergence between new and existing rent inflation is taking a lot longer than expected.
Economists still expect the pass-through to happen, but they have gotten less confident about how quickly it will come and how extensive it will prove. And a few are watching nervously as some measures of new apartment rents show signs of ticking back up. A rent measure tracked by the research firm Zelman & Associates is also showing early signs of renewed strength.
“If you had asked me six months ago, I would’ve said: Yes, they are going to have to converge,” said Mark Franceski, a managing director at Zelman. “Each month that has gone by and they haven’t, I’ve gotten less confident.”
So does O.E.R. have a place in inflation?
Because today’s housing inflation is essentially catch-up inflation, some economists think we should look past it. In Europe, some point out, the main inflation measure excludes owner-occupied housing altogether.
But while the measure gets a lot of heat for being “fake” or “inflationista,” or based on the frequent (but incorrect) assertion that it comes from a dubious survey, some economists stand by it.
“Let me break with the youngsters and defend O.E.R.,” said Ernie Tedeschi, who until recently was the chief economist at the White House Council of Economic Advisers. For one thing, it’s important to stand by the inflation metric you started with, he said. Moving the goal posts could undermine the public’s trust in the Fed’s commitment to fighting inflation.
Mr. Tedeschi also stressed that the O.E.R. tries to get at an important idea. As the value of housing changes over time, it shapes our economic lives.
If a homeowner were to move and needed to rent, doing so would be more expensive, for instance. (Europe, for what it’s worth, is working on developing its own owner-occupied housing costs measure expressly because it is an important component of inflation.)
Just as hard-to-measure forces in physics are critical to the way the universe works, Mr. Tedeschi said, the value we derive from where we live matters enormously to the functioning of the economy — even if it’s complicated.
“O.E.R. is sort of the dark matter of economics,” he said.