Rosalind Evans
Understanding the rate at which consumer prices rise may appear simple on the surface. However, the reality is far more intricate due to various idiosyncrasies in how categories such as housing, technology, and health insurance are measured in the consumer price index (CPI). These peculiarities often lead to discrepancies between inflation rates and the actual cost burden on consumers.
Economists warn that this has significant implications, potentially influencing policymakers to persist in escalating interest rates, thereby exerting unnecessary pressure on the U.S. economy.
“Big decisions that can steer the economy towards or away from the recession are made based on these rather imprecise measures that can be challenging to align with reality,” stated Mark Zandi, chief economist at Moody’s Analytics.
Let’s delve into three CPI categories where this discrepancy becomes apparent.
- Housing The housing sector is crucial in the CPI and, thus, an important indicator of inflation.
For an average American household, housing is the most significant expenditure. Consequently, the “shelter” category, which quantifies the cost for renters and homeowners, constitutes over a third of the CPI weighting – more than any other category.
While every component of the CPI carries some distinctive measurement challenge, Zandi noted that housing is particularly significant. It is the primary driver of the inflation engine.
The “shelter” pricing changes were relatively stable pre-pandemic. However, COVID-19 disrupted this trend. Economists noted that housing costs skyrocketed and then slowed down, even dropping in some regions.
Nationally, rents grew by 5% in April compared to the previous year, averaging about $2,018 monthly, as per Zillow Observed Rent Index data. This was a notable deceleration from the 17% growth recorded from April 2021 to April 2022.
The issue lies in the delay of the CPI in capturing these price trends.
The CPI operates with a significant lag, usually six months to a year, for current housing price fluctuations to fully reflect in the inflation data, according to economists.
Deputy chief U.S. economist Andrew Hunter at Capital Economics pointed out, “It doesn’t necessarily provide an accurate snapshot of the present state of the housing market.”
This lag arises because the U.S. Bureau of Labor Statistics gathers rent data from sample households every six months. Additionally, the data collected from these households, divided into six subgroups, is staggered, meaning it takes about a year to gather data from all subgroups.
Economists predict a significant slowdown in overall inflation in the latter half of the year as the CPI adjusts to the cooling housing prices.
Another quirk is in the “owners’ equivalent rent” subcategory. The BLS gauges price changes for homeowners, using a survey reflecting the rental price homeowners think they would fetch for their homes. Although somewhat linked to market rents, this measure doesn’t necessarily affect homeowners, particularly those who own their homes outright or have a fixed mortgage.
- Health Insurance Health insurance costs have decreased by about 4% a month since October, per CPI data, but consumer out-of-pocket costs have not necessarily followed suit.
According to the Kaiser Family Foundation, the average individual with employer-sponsored family health insurance saw premiums rise from $497 in 2021 to $509 in 2022.
The inconsistency stems from the government’s method of calculating health insurance inflation. Instead of tracking direct consumer costs like premiums, the government uses an indirect method, partly based on health insurers’ profits, reflecting consumer prices.
Zandi suggests that health insurance inflation rates could turn positive in fall 2023 and remain so into 2024 due to these dynamics. Health care might be among the few consumer categories recording higher inflation towards the end of the year, even as most other categories are slowing.
- Consumer Electronics Consumer electronics, including smartphones, TVs, and computers, were among the few categories that saw a decrease in prices in 2022, continuing into 2023.
However, the discrepancy appears in the “hedonic quality adjustment” used by the BLS to account for improvements in quality over time in certain products.
This adjustment can create an illusion of declining prices. Consumers may be getting better quality electronics for their money, leading to perceived price deflation.
Kenneth Kim, senior economist at KPMG, elucidated, “In this context, it could be considered a price decrease because consumers are receiving greater value for their money.”
The measurement of inflation is more complex than it might appear. The peculiarities in assessing the CPI categories, such as housing, health insurance, and consumer electronics, make the task intricate and complex. With this in mind, economists, policymakers, and consumers should approach these metrics with a deeper understanding and a critical eye to make informed decisions. As we continue to navigate economic shifts and changes, staying informed and adapting to these realities is imperative.
