Market Rents and CPI Shelter Inflation

Recent research finds that the shelter component of CPI inflation responds with a lag to movements in market rents—the rents that tenants pay when they move into a new dwelling. This paper seeks to improve our understanding of this fact. We start by identifying three sources of lags between market rents and CPI shelter: the rents of most tenants are set in long-term leases; rents are smoothed for continuing tenants who renew leases; and CPI shelter inflation is measured with rent changes over six months. We incorporate these lags in a model of shelter inflation and compare the model to monthly data since 2015, using the Zillow Observed Rent Index to measure market rents. We find that the model performs fairly well, suggesting that it may be useful for understanding and forecasting inflation.