Sticky Rents and the CPI for Owner Occupied Housing (Working Paper)

This paper examines the implications of sticky rents on the measurement of owner-occupied housing in the Consumer Price Index (CPI). I argue that market and not average rents are the most theoretically justified measurement of owners’ equivalent rent (OER), and that the current measurement of rental inflation using average rents is methodologically incorrect. A new data source is used to construct a market rent measure to compare to the existing CPI measure of owner-occupied housing inflation for the Baltimore/Washington D.C. CMSA. The results show that market rents reflect housing market turning points sooner, and show a larger post-housing bubble decline in rents. In addition, market rents are shown to forecast overall inflation better than average rents. The results suggest that switching to market rents may allow the Federal Reserve to be more responsive to housing bubbles.