Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Inflation Gap Between What You Pay and What CPI Shows
Transcript
- Lucas: So the latest CPI came out a couple of months ago — May 2026 — and headline inflation is running at about 2.3 percent. Core, stripping out food and energy, a touch higher. The bond market's ten-year breakeven rate is basically flat at 2.23. Markets are cheering, Fed's probably done hiking. But if you're a renter in any major city, you're looking at your bank statement and thinking, what planet are these numbers from? Luna: Yeah, it's a real disconnect. I've been seeing rent data from Apartment List and Zillow — actual market rents — up something like six or seven percent year-over-year. How is that not showing up in CPI? Lucas: It's a great question, and it cuts to the heart of how inflation is actually measured. The Bureau of Labor Statistics does track rent — that's the 'rent of primary residence' component. But for the two-thirds of Americans who own their homes, they use a different concept called 'owners' equivalent rent' — OER. Luna: Right, which is essentially asking homeowners, 'If your house were a rental, what would you charge?' That always struck me as a bit hypothetical. Lucas: Exactly. It's a survey question. They ask a homeowner, 'If someone were to rent your home unfurnished, how much do you think it would rent for?' And that estimated number becomes the imputed rent — the cost of housing services consumed by the owner. The idea is that even if you own, you're consuming a service — shelter — and we need to price that service. But the problem is, it's not a market transaction. It's an opinion. Luna: And those opinions tend to be sticky. People don't update their estimate every month the way a landlord would raise rent on a signed lease. So OER lags behind actual market movements. Lucas: That's exactly the issue. OER has a well-documented lag — typically six to twelve months behind market rents. And during periods of rapid change, like the post-pandemic spike, that lag means CPI understates real housing inflation on the way up, and overstates it on the way down. But here's the kicker: shelter makes up about a third of the CPI basket. So if shelter is being measured with a lag, a huge chunk of the index is effectively rearview. Luna: And this isn't new. This methodology has been in place since the 1980s. Why did they decide to use OER instead of just tracking actual home prices? Lucas: The logic was that a house is both a consumption good — the shelter it provides — and an investment asset. If you include home prices in CPI, you'd be mixing investment returns into a measure of consumption costs. Imagine if the price of Apple stock went up and the CPI said you're paying more to use your iPhone. It doesn't make sense. So they wanted to isolate the pure consumption value of housing. OER was the solution. Luna: But in practice, OER doesn't just lag — it's also less volatile. That smoothness can hide real pain for renters, who don't have the luxury of imputing their housing cost. Lucas: Right. And the BLS knows this. They publish both the official CPI and an experimental index that uses market rents for all housing. That alternative measure consistently runs higher during inflationary periods. In 2022, at the peak, the gap was about two percentage points. Today, with actual market rents still rising around 6.8 percent annually, while CPI shelter reads about 4.1 percent, the gap is roughly 2.7 points. Luna: So if we adjusted CPI to use real rents across the board, headline inflation might be closer to 3 or even 3.5 percent, rather than 2.3. That changes the whole Fed conversation. Lucas: It does. And interestingly, the Fed's preferred inflation gauge — the PCE price index — also uses OER, but it weights housing differently. PCE gives shelter a smaller weight than CPI, about 15 percent versus 33 percent. So the Fed's inflation read is actually less influenced by the housing methodology debate. But it's still there. Luna: So for the average person, especially renters, the official numbers feel disconnected. And that breeds cynicism. I get it — if the government says inflation is 2 percent but my rent went up 8, I stop trusting the data. Lucas: And that's dangerous, because CPI is used to adjust Social Security payments, tax brackets, union contracts, even school lunch prices. If the index understates real inflation for a significant portion of the population, those adjustments are inadequate. Retirees on fixed incomes are especially exposed. Luna: That's a big deal. So what's the alternative? Could the BLS ever switch to a market-rent-based measure for homeowners? Lucas: There's been debate. Some economists argue for a 'rental equivalence' approach using actual rents for similar properties, not hypotheticals. But the BLS has been cautious, partly because changing methodology would break the historical continuity of the index. And there's a legitimate concern: if you use market rents, you'd need to adjust for quality differences — a rented house is often different from an owner-occupied one. It's not trivial. Luna: Still, it feels like the current system benefits one group: homeowners who see their imputed rent barely budge while their home equity soars. They get a low CPI print, and a wealth boost. Renters get the short end. Lucas: That's a sharp way to put it. And it's true. The OER methodology essentially subsidizes homeowners in the inflation narrative. But there's another layer: the CPI also weights items based on spending patterns from a survey called the Consumer Expenditure Survey, which is updated every two years. That survey tends to underrepresent the spending of high-income households, who spend more on services like healthcare and education — categories that have been rising faster than goods. Luna: So the basket itself might be off for certain demographics. A low-income renter spends a much bigger share of their income on housing and food than the average consumer, so even if the overall CPI is accurate for the mean, it's not for them. Lucas: Exactly. The BLS actually publishes 'CPI for elderly' and 'CPI for urban wage earners' — different sub-indexes. But the headline number is the one that gets all the attention. And that number, because of OER's lag, is currently giving a more benign picture than reality for many. Luna: So when we hear 'inflation is cooling,' we should add a mental asterisk: *if you're a homeowner whose imputed rent hasn't changed much, and if you don't rent, and if your spending matches the average basket. Lucas: Exactly. And look, I'm not saying CPI is useless. It's a sophisticated, carefully constructed index. But it's a statistical abstraction, not a universal truth. The more we understand what's in the black box, the better we can interpret it. And speaking of understanding, if you find these conversations helpful — if walking through the economy with us has made something click — there's a simple way to keep the show going ad-free and independent. Luna: Yeah, we don't run ads, and that's intentional. The podcast stays up because of listeners who chip in a couple of dollars a month. It genuinely makes a difference. Lucas: It does. If you've gotten value from the show, you can support us at buy me a coffee dot com slash fexingo. That's all lowercase. Even a one-time contribution helps keep the lights on and lets us keep digging into topics like this without any sponsor pressure. Luna: And we really appreciate it. Okay, back to the housing inflation gap — because there's another wrinkle I want to get into: the difference between what CPI says about rent and what the private data says about actual leases. Lucas: Right. Private data sources like Zillow, Apartment List, and RealPage track actual signed leases — new rents, not existing ones. And they show a different picture. For example, in May, new-lease rents were up about 6.8 percent year-over-year nationally, while CPI's rent index was up about 4.5 percent. The gap is about 2.3 points. Luna: But CPI also includes renewals, which tend to be lower. So if you've been in your apartment for two years, your rent increase might be capped at 3 percent, while a new tenant moving in next door pays 10 percent more. CPI averages those together, which dilutes the pain for newcomers. Lucas: Exactly. And the mix matters. In a tight market with high turnover, new-lease rents dominate, but CPI still gives heavy weight to the slower-moving stock. The BLS does sample both new and existing tenants, but the lag remains. Luna: So what's the upshot for monetary policy? If the Fed is looking at CPI and PCE to set interest rates, and those measures are understating housing inflation, they might keep rates lower than they should, which could fuel more inflation down the road. Lucas: That's the risk. Some Fed officials have acknowledged the lag, but they argue that over time, OER converges to market rents. The problem is that the convergence can take years, and in the meantime, policy is based on stale data. There's a paper from the San Francisco Fed that found OER lags market rents by about 12 months on average, with a standard deviation of about six months. Luna: So a year. That's a long time when you're making rate decisions every six weeks. Lucas: Exactly. And it's not just housing. The same issue pops up in other categories where prices are imputed or sampled infrequently. For example, used car prices in CPI use a different methodology than new cars, and there's been a persistent gap between what CPI says and what auction data shows. Luna: We talked about that in a previous episode. But the housing one feels bigger because it's such a large share of spending. Lucas: It is. And I think the key takeaway is: when you hear a headline inflation number, ask yourself 'whose inflation?' For a homeowner with a fixed-rate mortgage, their housing cost might be flat. For a renter in a booming city, it might be up 10 percent. The average masks a lot of variance. Luna: And that variance is exactly why we keep coming back to this topic. It's not just academic — it affects how much your Social Security goes up, how your rent is adjusted, even how much your student loan payment might change under income-driven plans. Lucas: Right. So the next time you see 'CPI at 2.3 percent,' remember the asterisk. It's a useful number, but it's not the whole story. And with that, I think we've covered the gap. Thanks for listening to Inflation Explained with Fexingo.