Q&A: What can rent prices reveal about inflation and the economy?

UNIVERSITY PARK, Pa. — Tracking rent prices may help businesses and policymakers understand where inflation is headed months in advance of government inflation reports, according to researchers at Penn State’s Smeal College of Business who developed the Penn State/ACY Alternative Inflation Index. The Penn State index was recently incorporated into the Bloomberg Terminal, a software system that serves financial professionals with real-time market data, news and analytics.

Introduced by Penn State professors Brent Ambrose, Ed Coulson and Jiro Yoshida, the Penn State/ACY Alternative Inflation Index tracks marginal rent — what commercial landlords charge to lease new housing units at current market rates — to measure inflation. This approach differs from the housing component of the Consumer Price Index released monthly by the U.S. Bureau of Labor Statistics (BLS), which relies on surveys of mainly renewal rental rates for long-term tenants that may reflect older price movements in the housing market, the researchers explained.

Ambrose, the Jason and Julie Borrelli Faculty Chair in Real Estate and director of the Borrelli Institute for Real Estate Studies (BIRES) at Penn State, and Yoshida, the Arthur P. Pasquarella Professor of Business and BIRES associate director, explained in the following Q&A why rent prices are crucial for understanding inflation and how their index can help professionals and policymakers plan for future economic needs.

Q: How important are housing indicators like rent prices for tracking inflation?

Ambrose: Rents make up about 40% of the inflation indices that the government uses — the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index. It is the largest single component of the inflation index and is often considered less volatile than other factors driving inflation, like gas or food. We show that rent is not as stable as is often considered.

Yoshida: In the recent past, when CPI inflation has been regarded as very stubborn or very high, a majority of that high inflation was due to the housing component. The reason is that the CPI survey relies on renewal rent, which tends to steadily increase over time. So, even though other prices like food and energy fluctuate and may even decrease, the housing component remained positive and high, which in the past created very stubborn CPI inflation. Experts’ perception, analysis and policymaking depend on that CPI reading.

Q: What advantages does your alternative inflation index offer?

Yoshida: Our index captures market conditions in a more vivid way than the method that the government uses. The government has used the current method for measuring CPI and PCE for years. Because they like to maintain consistency over time, they cannot really change their methodology quickly. But we think we need more alternative information about inflation because the inflation measurement is not easy and straightforward. The BLS uses the CPI survey mainly for long-term tenants. Every six months, the same tenants respond to the survey. But problems may arise when a new tenant comes in, and that new tenant may not be cooperative, or when old tenants move out, BLS may lose observations from those units.

Marginal rent eventually captures the average of both renewal long-term tenants and new tenants. When new tenants move into a unit, the landlord typically tends to change the rent significantly to catch up with the market. The change from the old tenant to the new tenant can be big compared to the renewal rent. If we average all these big changes between tenants and small changes for the same tenant, and take the average of all renters, then that average rent change over time is captured by the marginal rent change. Our index of capturing marginal rent provides significant complementary information about general inflation in the economy, in addition to the public official inflation measurements.

Another benefit of our alternative inflation index is that during government shutdowns, when the BLS was unable to produce inflation measures for several months, we continued to publish our index, providing new information to the market.

Ambrose: The CPI is used in many ways in various contracts, and many rates are indexed against the CPI. So, there's a quite reasonable incentive for BLS to not change the definition of the CPI, because you have all these contracts that have been created and written that are based on that measure, and you'd want to preserve that consistency, otherwise you wouldn't have valid contracts anymore. But if you're the Federal Reserve, and you're trying to target inflation and set economic or fiscal policies to keep inflation at a certain level, then CPI may not be the right measure. You might want to have this other way of looking at inflation as an indicator for deciding if you should stimulate the economy or maybe slow down the economy. Or if you're a real estate developer and you want to know what rents are actually doing in the economy, our measure gives you a much more accurate view of where the housing market currently is than the CPI.

We used an analogy in one of our papers to help illustrate this: Imagine that the Federal Reserve is driving a bus; the bus represents the economy, and everybody in the economy is sitting in the bus. In this analogy, the Federal Reserve is looking at various instruments on the dashboard and viewing the road through the rear-view mirror, which represents the CPI. Meanwhile, some of the passengers in the bus feel what's ahead and are calling out, "Hey, there may be a curve coming up." But the Fed does not see the curve in the rear-view mirror. Our measure could potentially serve as an additional forward-looking sensor on the dashboard as they navigate the road ahead.

Q: How can including your alternative inflation index on the Bloomberg Terminal assist policymakers and professionals?

Yoshida: Our index leads the official CPI measure on average by seven months, according to past research. What that means is that because we keep track of marginal rent in the market, which captures the market condition right now, that current market condition is gradually and slowly reflected in the official CPI over months. When we see a new change in our inflation index, after 9 months or 12 months or sometimes later, the official index tends to move in the same direction. That’s not always the case, but it tends to be that way. The usefulness for policymakers, investors and businesspeople is that our index is a leading indicator of the official inflation measure by many months. Including the data in the Bloomberg Terminal makes it more accessible to investors and policymakers.

Ambrose: This work began as an academic research project. As a service to society — essentially as part of the mission of a research university — we created this website where we update the index on a monthly basis. People found our index and started using it. The three of us previously published a series of papers in peer-reviewed journals that document the development of the index, and other academics have published articles that use this information as part of their data for their research. We've had businesses contact us saying that they're using it too. And as a result of those uses, Bloomberg decided to incorporate the index in the data they provide to their customers on the Bloomberg Terminal. The data was always out there, but now, as part of the Bloomberg Terminal, it is more accessible. Professionals can easily incorporate our data series with all the other data series that are in the terminal.