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 89 cents for a hamburger. When the new model of the car goes up to $26,000 we may not realize it, but when the hamburger goes up from 89 cents 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 on the corner. 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, 2012.
Students: Have you personally noticed any inflation? How have higher gasoline price affected your spending or driving habits?
Note: Unless otherwise cited, the quoted materials in this lesson are from the Bureau of Labor Statistics Economic News Release, "Consumer Price Index Summary," April 13, 2012.
U.S. Bureau of Labor Statistics Announcement
Consumer Price Index Summary, March 2012
Released April 13, 2012
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 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 0.3 percent in March, maybe not enough 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 2011 cost them $102.70 in March of 2012. $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 9 percent more for gasoline in March 2012 than you did a year ago.
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 the rise in gasoline prices in March 2012 notice as much when the price dropped 1.5 percent in August, 2009?
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 0.2 percent in March after increasing 0.1 percent in February. Most of the major components increased in March, with the indexes for shelter and used cars and trucks accounting for about half the total increase for all items less food and energy. The indexes for medical care, apparel, recreation, new vehicles, and airline fares increased as well, while the indexes for tobacco and household furnishings and operations were among the few to decline in March."
"The indexes for food, energy, and all items less food and energy all increased in March. The gasoline index continued to rise, more than offsetting a decline in the household energy index and leading to a 0.9 percent increase in the energy index. The food index rose 0.2 percent as the index for meats, poultry, fish, and eggs increased notably"
Students: Make sure you are clear about the difference between the reported CPI-U and the "core" rate of inflation. Which one is more meaningful to you?
Figure 1, below, breaks down the changes in the CPI-U for February and March, 2012 and for the last twelve months by major spending category. Note the categories with significant changes.
Students: Look at the price level changes for different product groups and suggest why those prices have changed more or less than the average? Have political, economic or natural events impacted some prices more than others?
Use this BLS search page to select CPI data for specific spending categories. http://data.bls.gov/cgi-bin/surveymost?cu ]
Selected Consumer Price Index Data for March 2012
"The food index rose 0.2 percent in March after being unchanged in February. The index for food at home, unchanged in February, rose 0.1 percent in March. The index for meats, poultry, fish, and eggs rose 0.8 percent, its largest increase since May. The index for other food at home also rose in March, increasing 0.3 percent"
U.S. food prices are getting higher, but we are not experiencing the much greater increases in food prices as some other regions of the world.
All Items Less Food and Energy
"The index for all items less food and energy increased 0.2 percent in March after a 0.1 percent increase in February. The shelter index increased 0.2 percent, the sixth straight such increase, with the indexes for rent and owners' equivalent rent both increasing 0.2 percent."
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?
Not seasonally adjusted CPI measures - the actual numbers
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 2.7 percent over the last 12 months to an index level of 229.392 (1982-84=100). For the month, the index increased 0.8 percent prior to seasonal adjustment."
In March, 2012, the CPI-U "market basket" cost $229.39. In 1983, the same "market basket" cost $100. A year ago, the same basket of goods and services cost $223.47. Most of the difference over the past year has been higher energy costs. Again, the big variable is how you spent your income over 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 "other" category includes items such as tobacco products, personal care products and services, and other personal services.
Students: Do these categories make sense? What products do they suggest should be part of the CPI "market basket"?
For information about the make-up of the BLS market basket, go to "How is the CPI market basket determined?" in the BLS FAQs .
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 increased, the unemployment rate has decreased. One piece of data may confirm 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. Note the "recovery" in 2010-2011.
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: The business cycle illustrates the growth pattern of the U.S. economy over the past couple of years - expansion, peak, contraction, and trough. Are we still in a recession?
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.
One of the Federal Reserve System's (Fed) mandates is to maintain a stable price level and purchasing power. The Fed 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: Does the Phillips Curve make sense? Does it apply in this recessionary period?
A little inflation may be back after a period of relatively stable prices. The CPI-U increased 0.3 percent in March and an increase of 0.4 percent in February, 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 2.3 percent in the past twelve months. Gasoline and food prices accounted for much of the all items price level increase in March. The average gasoline price (all types0 has increased 59 cents sinec december, 2011.
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 lived in an extended period of higher energy and food prices.
What do you think?
Students click the start button below to complete interactive exercises to assess their knowledge of the Unemployment lesson.
Next, answer a question on the below interactive notepad.
The BLS tracks a variety of international data, including prices. Take a look at some of the international data.
Go to, "Consumer price indexes in nine countries, percent change from same period of previous year, 1995-2012." Read the inflation data about the nine industrialized nations.
- Do you see any patterns?
- Which nations have had higher inflation rates than the U.S.? Lower rates?
What do you think may account for the differences?
Go to, "U.S. Import and Export Price Indexes, March 2009 U.S. Import and Export Price Index, March 2011 U.S. Import and Export Price Indexes, March 2009 ." Read about the price changes for U.S. imports and exports.
"U.S. import prices rose 2.7 percent in March, the U.S. Bureau of Labor Statistics reported today, following a 1.4 percent advance in February. The March increase was driven by both higher fuel and nonfuel prices. The price index for U.S. exports increased 1.5 percent in March after rising 1.4 percent the previous month."
- How much have import and export prices changed compared to U.S. domestic prices?
- What imported goods have had the greatest price increases recently? Exports?
- Which nations' goods have increased in prices the most? Least?