Headline Inflation Is Lower Than It Appears

September 13, 2023

Headline Inflation Is Lower Than It Appears

By: Kitty Richards, Chris Becker and Bilal Baydoun

Headline inflation as reported by the Bureau of Labor Statistics (BLS) rose by 3.7% year-over-year in August 2023, but when real-world housing cost data is incorporated, that figure drops to 2.4%, and year-over-year inflation in June and July was below the Fed’s 2% target.

Most of the rise in month-over-month inflation in August was driven by higher energy costs – something that the Fed has no control over. Thus, many analysts are focused on core inflation, excluding food and energy, which ran at 4.3% over the past twelve months, continuing its downward march but still exceeding the Fed’s target.

However, even this measure hides the true story, as 70% of core inflation was driven by the BLS’s measure of shelter costs, which can lag behind market data by up to a year.

“Headline inflation is currently more than a percentage point lower than official reports suggest.””

If current-market rental rates, as measured by the Zillow Observed Rent Index (ZORI), are substituted for the BLS shelter measure in the Consumer Price Index (CPI) calculation, headline inflation is currently more than a percentage point lower than official reports suggest.

When the BLS measures the cost of a carton of eggs, they go to stores around the country and ask, “What does a dozen eggs cost right now?” The official CPI shelter cost measure, on the other hand, is based on what people are currently paying in rent, whether they just signed a new lease or signed their lease a year ago. This is helpful for looking broadly at costs, but it is less helpful for drawing conclusions about macroeconomic conditions.

For judging what’s going on in the housing market right now, it can be more useful to look at data about new leases, as collected by ZORI. As you can see in the chart above, ZORI inflation rose much faster and higher than BLS Shelter inflation, peaking in early 2022, then began a precipitous fall. Current market rental inflation is now back to pre-pandemic levels. Meanwhile, the BLS shelter inflation measure wasn’t able to keep up with rapid changes. It rose much more slowly last year and is still rising as last year’s rental market prices work their way into the BLS shelter measure.

When you re-calculate all-items CPI using ZORI instead of BLS shelter, you see the same thing. Using market rents, headline inflation rose sooner, peaked higher, and then fell faster than the BLS measure shows. This adjusted inflation measure now shows prices rising by only 2.4% year-over-year in August, and it was below the Fed’s 2% target in June and July.