Using data from the Bureau of Labor Statistics on the Consumer Price Index (CPI), students investigate the latest release for October 2014. Students will explore the difference between seasonally unadjusted and adjusted data are and the role of each.

KEY CONCEPTS

Business Cycles, Consumer Price Index (CPI), Inflation, Macroeconomic Indicators, Macroeconomics

STUDENTS WILL

  • Analyze the most current report from the Bureau of Labor Statistics with respect to the Consumer Price Index and its components
  • Understand the purpose and need for seasonal adjustments in the data
  • Identify situations when unadjusted data vs. adjusted data should be used

Current Key Economic Indicators

as of December 9, 2014

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in October on a seasonally adjusted basis. Over the last 12 months, the all items index increased 1.7 percent before seasonal adjustment. Gasoline and other energy indexes declined, offsetting increases in shelter and other indexes to leave the seasonally adjusted all items index unchanged. The core inflation index rose 0.2 percent in October.

Employment and Unemployment

According to the November report of the Bureau of Labor Statistics, the unemployment rate stayed constant at 5.8%, while total nonfarm employment rose by 321,000. Employment gains continued in retail trade, food services and health care, but also extended to a number of white collar job sectors as well, including financial, insurance, and real estate. In addition, the number of long-term unemployed (those unemployed at least six months) fell by over 100,000.

Real GDP

The revised estimate for real GDP growth in the third quarter of 2014 was 3.9%, an increase from the initial estimated third quarter growth of 3.5%, but down slightly from the second quarter growth of 4.6%. All components of GDP experienced increases in the third quarter, with the exception of private inventories, which decreased slightly.

Federal Reserve

The FOMC believes that the labor market has shown considerable improvement and the risks of inflation rising above its 2% target are low. Therefore, the Federal Reserve announced plans to end its purchase of financial assets. In addition, the federal funds rate will remain at its current low level. However, the FOMC has signaled its willingness to increase the federal funds rate if inflation shows signs of rising above the 2% target.

INTRODUCTION

Every month, the Bureau of Labor Statistics releases the "Consumer Price Index Summary", a comprehensive report on the CPI and inflation rate. Each report provides the current estimates of price level changes for various categories of goods and services, as well as for major metropolitan areas. 

This lesson uses the November 20, 2014, release for October 2014, to explore the relative changes by category, the concept of seasonal adjustments and the role of these adjustments in the CPI.

RESOURCES

  • BLS Feature: Focus on Prices and Spending- What Does the Producer Price Index Measure? The BLS breaks down the official definition of the Producer Price Index to clear up common misconceptions about prices, production, and price pass-through within the PPI.
    www.bls.gov/ppi/
  • BLS, Frequently Asked Questions webpage
    Frequently Asked Questions

PROCESS

  1. Refer students to the latest Bureau of Labor Statistics report on inflation for October 2014: www.bls.gov/news.release/cpi.nr0.htm

    Ask students: What is the inflation rate over the last 12 months? (1.7%). How has that changed from last month? (it stayed the same). What categories experienced an increase in inflation? (shelter and food). Which experienced a decrease? (energy).
     
  2. Ask students to look at the following graph, paying particular attention to the red line:



    Tell them that when a data series shows patterns in (a) timing; (b) direction; or (c) magnitude, then those fluctuations need to be corrected so that we know we are seeing a true trend.

    Ask them if they see any recurring patterns in the red line graph (there is a dip at the end of every year). Ask what they think is causing that pattern (widespread holiday sales). 

    Point out that if we simply looked at the change in CPI from October or November to December, we might erroneously conclude that the CPI fell due to underlying changes in economic variables, such as a sudden drop in aggregate demand. Instead, we see that this occurs every year.
     
  3. Tell students to look at the graph again, this time focusing on the blue line. Ask students what they notice about the difference between the two lines (the blue line is less volatile). Tell them when we seasonally adjust the CPI data, those seasonal patterns are accounted for--the dips at the end of the years are smoothed out. 

    Ask students what they notice about the overall trend of the two lines (both increase in fairly close proximity). 

    Tell students that holiday sales are one source of seasonality in the CPI data. Ask if they can think of other examples of seasonal influences on prices (answers could include timing of harvests, production cycles such as new car model releases, back to school sales).
     
  4. Tell students to go to the section of the report with the heading, "Energy". Ask students how much gasoline prices fell in October (3.0% after seasonal adjustment; 6.3% before seasonal adjustment).

    Remind students that seasonal adjustments tell us about the relationship between a data series and the typical changes in the data series at the same point in time. 

    Ask what the adjusted and unadjusted gasoline indexes tell them about the typical behavior of gasoline prices in October (because the seasonally adjusted index fell, that means the actual drop for October was unusually large compared to the typical October). 

    Ask students what the seasonally adjusted gasoline index for the month of October would have been if the actual drop in prices had been the same as past Octobers (it would have been the same as for the previous month--the change in the seasonally adjusted index would have been 0%). 
     
  5. Tell students that one of the uses of the CPI is as the basis for payment escalators--cost of living adjustments that are written into some employment contracts, Social Security payments, and pension plans. 

    Tell students to imagine that they have an employment contract that includes an automatic cost of living adjustment. Over the past year, the unadjusted CPI increased by 3%, and the seasonally adjusted CPI increased 2%. Which measure of the CPI should be used when determining your salary increase? (the unadjusted. The unadjusted CPI represents the actual prices paid for goods and services, so it is a better measure of the changes in the cost of living.

    Tell students that over the course of a year, the difference between the unadjusted and adjusted CPI is usually quite small. Point out that on the graph, an individual month's difference may be fairly large, but that the two trends track very closely over the course of a year.

ASSESSMENT ACTIVITY

CONCLUSION

Each month, the Bureau of Labor Statistics releases the report on the Consumer Price Index and inflation. The report (released November 20, 2014) indicated that inflation rose 1.7% for the 12-month period ending in October, an annualized rate unchanged from the previous month. 

The data series released by the government often show patterns involving timing, magnitude, and duration. Because the CPI changes in predictable ways at predictable times of the year, these changes need to be accounted for in the data in order to isolate the effects of underlying economic trends. The resulting adjusted series then gives us information on whether the actual data is performing as that in previous, similar periods of time.

EXTENSION ACTIVITY

Remind students that the gasoline index has dropped 8% over the past 3 months. Ask them what this implies about spending in the other sectors of the economy (consumer spending is likely to increase; non-energy business investment is not likely to increase in the short-run; energy sector business investment might decrease in the short-run; declines in energy stock prices can undermine confidence).

EDUCATOR REVIEWS