December 05, 2018 • By Laurie McLaughlin
The Bureau of Labor Statistics doesn’t accurately capture the fluctuations in housing rental rates, according to a recent study by a UCI Paul Merage School of Business professor and two colleagues.
It turns out that housing rents fall more rapidly during economic downturns and rise more rapidly during upturns than the data presented in the reports issued by the Bureau of Labor Statistics.
The bureau uses rental-rate data that is many months old, and since housing prices are a large part of the inflation calculation, using contemporaneous rental data would have substantial implications for how inflation is measured. In contrast, the Merage School professor and his colleagues applied a model measuring current national rental housing rates.
The Bureau of Labor Statistics’ consumer price index (CPI) is integral to the way most Americans live. Predominantly a measure of inflation, the index is used by government, businesses and individuals when making economic decisions, and the index influences Social Security payments, lease and labor contracts, income tax brackets, economic policy and much more, in addition to helping determine real gross domestic product.
Within the index’s market basket is a measurement of the housing component. But the researchers suggest in their recent paper, “Housing Rents and Inflation Rates” that the measurements within the index do not accurately reflect rental rates.
“Since changes in housing rents comprise a significant portion of price inflation and given the importance of housing to the economy, we focus on how differences in measuring the housing component affect the construction of the CPI,” state the authors, Edward Coulson of the Merage School’s Center for Real Estate, and Brent Ambrose and Jiro Yoshida of Penn State.
“We then demonstrate that current estimates of housing rent inflation, which understate the variation in the actual rent inflation with significant lags, can have material and economically significant effects on a variety of economic policies and decisions.”
Therefore, “the official [inflation] rate was overestimated by 1.7 percent to 4.2 percent annually during the Great Recession but is underestimated by 0.3 percent to 0.9 percent annually during the current expansionary period.”
The researchers computed rental rates across the United States in their model with calculations incorporating data from newly-signed leases as well as the data on the value of rental buildings and the rent-to-value ratio, all of which results in a calculation of rental rates that more accurately reflects current market conditions.
This is in contrast to the Bureau of Labor Statistics’ use of unchanging rental rates for sitting tenants, which don’t accurately reflect fluctuations in the housing market. The researchers’ nationwide collection of data also distinguishes their study from other similar reports that sample much smaller regional areas.
“The Federal Reserve bases its policy on what they observe the inflation rate is, and there’s often been talk as we are coming out of the recession of waiting until we had a 2 percent inflation rate before interest rates should be raised,” says Coulson. “We found that using our measurement instead of the official measures, we reached the 2 percent mark a couple of years ahead of the official measure.
“So inflation was higher coming out of the recession, and inflation was a lot lower, in our opinion, as we entered the recession,” Coulson adds. “Rents fell by a much faster rate than what the BLS measured, and we should have had expansionary monetary policy sooner.”
The impact of measurement errors can be enormous because these price indexes are the basis of a wide range of economic statistics, contracts, public policy programs, asset prices, and most importantly, corporate and consumer decision making, the study says. The study is their third paper in a series exploring the impact that housing rents have on the measurement of inflation.
“Anything that’s indexed to inflation would be affected by what we are doing, because it changes the way you measure inflation,” says Coulson. “We are trying to make the inflation rate more responsive to current market conditions.”