Inflation Is Decelerating... Its Effects on Consumers Are Not

Chief Economist Eugenio J. Alemán discusses current economic conditions.

We understand that many economists/analysts/market participants are already discounting inflation as a serious problem for the U.S. economy. Even if this seems correct on the surface, the problem is very different for those who suffer the most from higher prices – middle- and lower-income individuals. Typically, individuals at these income levels are normally not able to shield themselves from higher prices as higher- income individuals are able to do. One of the biggest reasons for this is that lower- and middle-income individuals and households basically spend all their income on necessities, which have seen large increases in prices over the last several years and consequently have very little to nothing left at the end of each month. True, the rate at which these prices are rising is coming down, or what is called the process of disinflation. However, the cumulative effects of the high rate of inflation during the last several years are still very much affecting Americans today, even if many of them have received increases in wages and salaries during the period.

Furthermore, probably a large percentage of Americans in the middle- and low-income levels are renters of their homes, which means that they suffer the higher costs of shelter that have occurred over the last several years. Those that have fixed mortgage rates loans have seen no increase in housing mortgage payments even if shelter costs have been very high. Thus, for high-middle- to high-income Americans, inflation has not been as damaging as it has been for middle- to low-income Americans. Probably the only exception to these higher housing costs, other than renters, are those who are buying a home at higher interest rates today compared to the past. However, those that are buying homes today are typically doing so because they can afford to qualify for higher mortgage rates loans, which is very different than what happened in the buildup to the Great Recession. According to the U.S. Census Bureau, the homeownership rate in the U.S. during the third quarter of this year was 66.0%. This means that about 34% of U.S. households are renters and they are the ones who have suffered from the increase in shelter costs the most during the last couple of years.

Homeownership Rate in the United States

After discussing inflation for over two years, we are all familiar with the fact that shelter costs are by far the largest component of the Consumer Price Index, making up 34.4% of the Index. Shelter includes a variety of items, but over 95% can be attributed to two of them: Rent of Primary Residence and Owners’ Equivalent Rent of Residences (OER). This last one can be simply explained as the rent that one would have to pay to rent the currently owned home, unfurnished and without utilities. OER has had a 98% correlation with the broader shelter CPI over the last 20 years, and therefore for this study, we’ll use OER as a proxy and disregard other items such as household insurance, lodging away from home, among others. As we discussed in previous Weekly Economics, shelter costs are known to be a lagging indicator as tenants tend to sign long-term leases, therefore locking in a certain price for an extended period, regardless of what the housing market does. Overall, if we apply a 12-month lag to shelter, we get a correlation with the overall headline CPI of about 70%, which is what one should expect, as this component alone makes up over one-third of the index.

CPI and Shelter CPI are Highly Correlated