Each month, the U.S. Bureau of Labor Statistics (BLS) releases an estimate of the level of the consumer price index (CPI) and the rate of inflation in the United States for the previous month. The report provides the most recent current and seasonally adjusted consumer price indexes for all urban consumers, urban wager earners, and the chained index, plus a breakdown by major expenditure groups. The BLS also collects price level data for major metropolitan areas and regions.
This lesson focuses on the April 15, 2011, BLS press release of data on the consumer price index for the month of March, 2011.
- Identify the current rate and recent changes in the consumer price index.
- Identify the factors that have influenced recent changes in the rate of inflation.
- Identify the potential policy implications of the current economic conditions, including deflation.
- Describe how inflation and deflation impact individuals, families, and different groups in the economy.
We see prices everyday of our lives. We see big prices like $25,000 for a new car and we see small prices like an 89 cent fast-food hamburger. When the new model of the car goes up to $26,000 we may not realize it, but when the hamburger goes up to 99 cents we do. When we get used to paying a particular price for something, it disturbs us when the price changes, but we can often find a substitute. If we purchase a particular item regularly, we may be more aware when the price changes.
Take gasoline, for example. Gasoline is, maybe, the one product where we may see the price every day. Gasoline prices are posted on big signs for all to see at the gas stations. Some people look for the lowest price and select a brand. Others may be loyal to a brand and choose to pay a little more for their brand. But unlike gasoline, most prices take a little more work to find. We have to go into the store and look for them. We may have to shop around at several stores to find a lower price for something we want. For everyday purchasing decisions, product prices are good information that helps us make choices.
Prices help us use our income to make decisions about the things we want - what to buy and what not to buy. When all prices (or most) increase and we experience the effects of inflation (an increase in the average price level in the economy) we face other decisions. We may have to make difficult choices, giving up some things to have others. Inflation - a rising rice level - erodes the purchasing power of our incomes and threatens our lifestyles. A falling price level - called deflation - sounds great, but may also have a harmful impact on the economy
Is inflation or deflation an issue today? Are prices increasing? Are they falling? Let's see what the Bureau of Labor Statistics has to say about consumer prices in March, 2011.
U.S. Bureau of Labor Statistics Announcement
Consumer Price Index (CPI-U): March 2011
Released April 15, 2011
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in March on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.7 percent before seasonal adjustment."
The "all-items" price level increased by just 0.5 percent in March, maybe not enough for most of the "market basket" items for you to notice. For the year, the price level increased by 2.7 percent - meaning that a market basket of goods and services someone purchased for $100 in March of 2010 cost them $102.70 in March of 2011. $2.70 over the course of the year may not be enough to really notice. Unless, of course, you make a living driving an automobile or a truck and you paid 14.4 percent more for gasoline in March 2011 than you did just three months ago in December 2010.
A "wildcard" like energy and food - products that tend to fluctuate more widely in price - will affect people differently, based on their consumption habits. Did those who complained about gasoline prices in March 2011 notice when the price dropped over 5 percent in May of 2010?
When the BLS reports on prices, it provides two basic numbers. One is the CPI-U, including a broad variety of goods and services. This measure of the price level is often referred to as the "headline" number.
The second number is referred to as the "core" rate of inflation and excludes energy and food prices that tend to fluctuate more. Excluding food and energy is assumed to provide a better picture of the general price level over time. The BLS uses the term "all items less food and energy" for this data.
From the BLS report: "The index for all items less food and energy rose 0.1 percent in March, a smaller increase than in the previous two months. The index for shelter rose slightly, as did the index for medical care. Several transportation indexes posted significant increases, including new vehicles, used cars and trucks, and airline fares. In contrast, the indexes for apparel and for household furnishings and operations both declined in March."
"Gasoline and food prices continued to rise and together accounted for almost three quarters of the seasonally adjusted all items increase in March. The gasoline index posted its ninth consecutive increase and has now risen 14.4 percent over the last three months. The household energy index rose as well, with advances in the fuel oil and electricity indexes more than offsetting a decline in the index for natural gas. The food at home index continued to accelerate in March, rising 1.1 percent as all six major grocery store food groups increased."
Students: Have higher gasoline prices impacted your spending or your driving habits?
Figure 1, below, breaks down the changes in the CPI-U for February and March, 2011 and for the last twelve months by major spending category. Note the categories with significant changes.
Figure 1: Percent Changes in CPI
All Urban Consumers (CPI-U)
U.S. City Average
(Seasonally adjusted, unless noted)
|CPI-U for All Items||0.5||0.5||2.7|
|Food at home||0.8||1.1||3.6|
|Food away from home||0.2||0.3||1.9|
|Gasoline (all types)||4.7||5.6||27.5|
|Fuel oil (1)||5.8||6.2||34.0|
|Utility (piped) gas service||3.4||-1.4||-5.5|
|All Items Less Food and Energy (core)||0.2||0.1||1.2|
|Commodities Less Food and Energy||0.2||0.1||0.2|
|Used Cars and Trucks||0.1||0.8||2.3|
|Medical Care Commodities (1)||0.7||0.5||2.8|
|Service Less Energy Services||0.2||0.2||1.6|
|Medical Care Services||0.4||0.1||2.7|
|(1) Not seasonally adjusted|
Selected Consumer Price Index Data for March 2011
"The food index rose 0.8 percent in March after rising 0.6 percent in February. The food at home index increased 1.1 percent in March and has risen 2.7 percent over the past three months. All six major grocery store food groups increased in March, with increases ranging from 0.5 percent for cereals and bakery products to 1.9 percent for fruits and vegetables."
"The index for food away from home increased 0.3 percent in March, its largest increase since September, and has risen 1.9 percent over the past 12 months."
U.S. food prices are getting higher, but we are not experiencing the much greater increases in food prices as some other regions.
"The energy index rose 3.5 percent in March after increasing 3.4 percent in February. It has increased for nine months in a row, rising 23.7 percent since June 2010." "The household energy index has risen 1.2 percent over the last 12 months, with the fuel oil index up 34.0 percent and the electricity index up 1.0 percent but the index for natural gas down 5.5 percent." Energy price highlights:
- The gasoline index rose 5.6 percent in March.
- The index for household energy advanced 0.6 percent in March.
- The fuel oil index rose 6.2 percent in March.
- The index for electricity increased 0.7 percent in March.
- The index for natural gas declined 1.4 percent.
All items less food and energy
"The index for all items less food and energy rose 0.1 percent in March after increasing 0.2 percent in each of the previous two months."
Take another look at the changes from February to March in Figure 1, above. Note the spending category indexes that increased in March. Compare those changes to energy and food. How important are energy and food prices in your family's budget? Did the items you typically purchase go up or down?
For the past year, the price index for all items less food and energy increased 1.2 percent. This is well-below the 1.9 percent average over the last 10 years. Again, look the last column in Figure 1. What categories increased and decreased? Did you experienc emore or less inflation than the average?
Studnets: Which is a better measurement of inflation ? The CPI-U for all items or the "core" CPI-U excluding energy and food?
Not seasonally adjusted CPI measures
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 2.7 percent over the last 12 months to an index level of 223.467 (1982-84=100). For the month, the index increased 1.0 percent prior to seasonal adjustment."
In March, the CPI-U "market basket" cost $223.47. In 1983, the same "market basket" cost $100. A year ago, the same basket of goods and services cost $217.63. Most of the difference over the past year has been higher energy costs. Again, the big varieable is how you spent your income ovee this time period. The CPI is a "weighted" index, meaning that each category of spending has a difference level of importance (weight) in the market basket. You might, for example, spend a larger portion of your income on clothing. If so, your "personal" price index probably did not increase as much in March as that of someone who spent a larger portion of their income on gasoline.
The Weighted Index
Figure 2, below, shows the weights of the major categories of items making up the CPI-U. Note how some categories (energy and other*) have changed greatly in price level since the base period of 1982-84. Other categories (apparel and recreation) have changed very little in their price level. The CPI-U for all items has increased from the base period when it was 100 by over 123 percent.
Figure 2: Consumer Price Index (CPI-U)
Weights and Index Levels by Category
|Spending Category||Weight*||Index Level|
|Food and Beverages||14.8%||225.479|
|*Weights were established as of December 2011.|
*The "other" category includes items such as tobacco products, personal care products and services, and other personal services.
Students: How does this weighted index compare to your spending habits. What percentage of your spending is in these categories? In your experience, which categories have the greatest weight?
Recent CPI-U History
Figure 3, below, shows the monthly changes in the CPI from 2002 through March 2011. Note the periods of slow price level growth and a few periods of more rapid price level growth. Also note the few months of decreases in the CPI-U, the most recent of which were in late 2008 - the beginning of the recession. At that time, many analysts feared a period of deflation - an extended period of price level decrease. Continued price level decrease may have signaled a longer continuation of the recession.
Connections between the CPI and Other Macroeconomic Data
It is sometimes instructive to find relationships between various macroeconomic data. These relationships may sometimes give us a more broad picture of the economy. For instance, there is a general relationship between output (GDP) and employment. As GDP increases, employment tends to increase. In the past several months, as real GDP has decreased, the unemployment rate has increased. One piece of data confirms the meaning of the other.
Figure 4, below, provides four sets of macroeconomic data - CPI, unemployment, real GDP growth and the federal funds rate target. Notice the long term relationship of periods of output growth and decline with the changes in the unemployment rate. This relationship makes sense as the number of employed is directly related to output. Some increase in output can be attributed to improvements in productivity, but growth is very much dependent on labor force growth and employment. In late 2008 and 2009, as U.S. real GDP declined, the unemployment rate increased substantially.
Figure 4: Selected Annual Macroeconomic Data
1999 - March 2011
|2009||-2.6||9.3||-0.4||0 to .25|
|2010||2.9||9.6||1.6||0 to .25|
|2011 (March)||--||8.8||2.7||0 to .25|
Business cycles or periodic fluctuations in growth and employment illustrate the relationships of some data (see Figure 3). When the National Bureau of Economic Research (NBER) tracks cycles in order to identify recessions, they use the combination of employment, GDP growth and other factors. How do consumer prices fit into this analysis? The NBER uses real GDP growth and real personal income as primary factors identifying business cycles. Using employment and income data adjusted for inflation allows the NBER to make more accurate comparisons from one data period to the next.
Students: Can you see the "cycles" in the data?
Inflation and GDP
Accurate measurement of gross domestic product or GDP growth is also dependent on the accurate measurement of inflation. A rise in the price level "inflates" the measurement of GDP growth - miscalculating real growth in the economy. A more meaningful measurement of the growth of output is real GDP - the nominal GDP measurement adjusted for the impact of inflation. Although CPI is the most common measurement of inflation for many uses, the adjustment of GDP uses a process based on the GDP deflator. Both the CPI and the GDP deflator are measurements of average prices, but the GDP deflator includes all of the goods and services produced in the economy, not just the CPI market basket.
The GDP is the market value of all goods and services produced in a year. Real GDP is the market value of those goods at a constant price level. Measuring the nation's output in a year at a constant price level means that you can accurately compare it to the output in another year.
CPI vs. GDP Deflator as Measures of Inflation
The rate of inflation rate determined by the CPI and GDP deflator are normally quite similar. Since the CPI uses a fixed market basked of goods and services, it assumes a fairly constant pattern of consumer purchases. Over time, the market basket may be changed, based on changes in consumer behavior. The GDP deflator uses a flexible basket of goods and services based on the actual quantities of goods and services produced in a year, while the prices of the goods and services are fixed. The GDP deflator uses a much larger quantity of goods and services.
The CPI does not take into account substitution - the tendency of consumers to choose lower priced goods in place of more expensive ones. Just the opposite sometimes happens, as consumers may choose to purchase more expensive goods as their incomes increase. The GDP deflator can take these substitutions into account. Because the GDP deflator assumes substitutions, it may underestimate the impact of inflation when consumers do not (are not able to) substitute. The CPI may overestimate the impact of inflation when consumers do substitute.
Most government agencies and many private contracts use the CPI to determine a cost of living adjustments (COLA). The Social Security Administration added a 5.8 percent COLA to Social Security benefits and SSI payments in January 2009, based on the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of 2007 to the third quarter of 2008. If there had been no increase in the CPI in that time period, there would have been no increase in benefits.
Inflation and Unemployment
Long-standing economic theory had assumed that there is a predictable trade-off between the impact of public policy decisions and economic change on inflation and unemployment. This theory, developed by New Zealand Economist William Phillips in 1958, was based on his observation of an inverse relationship between money wage changes (inflation) and unemployment in the British economy over a period of time. The "Phillips Curve" proposed that when unemployment is low, inflation tends to be high and when unemployment is high, inflation tends to be low.
The implication for policy makers was that "Keynesian" policies could be used to control unemployment and inflation. Increased spending can lower unemployment with the risk of a high rate of inflation. Policy makers face the Phillips Curve trade-off. Today, policy makers who propose to use monetary policy (lower interest rates) or fiscal policy (deficit spending) to stimulate the economy, and increase GDP and employment, are aware of its potential inflationary effect. The Phillips Cure theory lost favor in the late 1980s when there were periods of both high unemployment and high inflation, followed in the 1990s by periods of low unemployment and low inflation.
The Federal Reserve recognized this potential trade-off in its most recent monetary policy statement when it justified an aggressive stimulatory policy by saying that the current conditions did not include an inflationary threat. Low inflation provides room for aggressive policies to stimulate the economy. Should inflation become a real threat, the Fed may slow down growth of the money supply.
Students: Should the government or the Federal Reserve take more actions to prevent future inflation? That might mean slowing economic growth or cutting government spending. What do you think?
A little inflation may be back after a long period of relatively stable prices. The CPI-U increased 0.5 percent in March on a seasonally adjusted basis. Over the last year, the CPI-U increased 2.7 percent before seasonal adjustment.2.7 percent is close to the Federal Reserve's goal of a 2.0 percent annual price level increase.
The inflation "wildcard" is, again this month, energy and food prices prices. Excluding energy and food, the "core" CPI-U, "all items less food and energy," increased just 0.1 percent in March and increased 1.2 percent in the last year. Gasoline and food prices accounted for almost three quarters of the all items price level increase in March. The gasoline price index has increased for nine months in a row and has risen 14.4 percent in just the last three months.
For most of our spending categories, prices have been relatively stable, but the real story may be whether or not our incomes have kept up with prices and we can still purchase the same goods and services we did last year. For many families, higher gasoline price have meant giving up other consumption, so that they can drive to work or take a vacation.
Those who say that the "core" rate of inflation is a better long term measurement of the price level face criticism from many who have to live in an extend period of higher energy and food prices. What do you think?
Next, answer a question on the below interactive notepad.
1. How important is it to adjust economic growth or income data for the effect of inflation?