The consumer price index (CPI) during the month of October decreased by .5 percent (one-half of one percent). The rate of increase in the consumer price index over the past twelve months has been 1.3 percent.
In October, the core consumer price index, which excludes energy and food prices, increased by .1 percent (one-tenth of one percent).The core index has increased by 2.7 percent over the last twelve months.
Definition of Inflation
Inflation is a continual increase in the overall level of prices. It is an increase in average prices that lasts at least a few months. The most widely reported measurement of inflation is the consumer price index (CPI). The CPI compares the prices of a set of goods and services relative to the prices of those same goods and services in a previous month or year. Changes in the prices of those goods and services approximate changes in the overall level of prices paid by consumers.
The core consumer price index is the average price of the same set of goods and services, without including food and energy prices, relative to the price of the same goods and services without food and energy prices in a previous month or year.
In October, the consumer price index decreased by .5 percent following a similar .5 percent decrease in September and an increase of only .1 percent in August. In October, energy prices continued their rather dramatic fall that began in September.
The annual rate of change over the last three months was a decrease of 2.9 percent. Over the last 12 months, we experienced an increase in prices of 1.3 percent. Annual overall inflation rates from 2002 through 2005 were 2.4, 1.9, 3.3 and 3.4 percent.
The core rate of inflation (.1 percent in October) consists of changes in the consumer price index without the influences of changes in the prices of food and energy, which can fluctuate widely from month to month. The slight increase in the October index compares to .2 percent in each of the previous three months. Core prices increased more slowly in the last two months than the overall index due to the rapid decreases in prices of energy. The annual rate of decrease in prices of energy over the last three months was 43.8 percent.
Extra attention is given by forecasters to the core index as it tends to reflect more lasting trends in prices. Increases in energy prices over the last several years have caused other prices to increase more rapidly. As energy prices have fallen, the core index has continued to gradually rise. The slow upward trend core index has continued and is of concern to the Federal Reserve's Open Market Committee.
Food and beverage prices increased at .3 percent in October, about the same rate as in recent months. Housing prices did not change. Apparel prices fell. Transportation prices fell by 3.1 percent reflecting the significant decline in gasoline prices. Prices of recreation remained steady and education and communication prices rose a bit less than recent rates.
Figure 1 shows recent inflation data reported for each month. It is obvious that the monthly inflation figures change a great deal from one month to the next. However, the trend has been an increasing one over the last several months. It is however difficult to tell what the trend over a longer period of time has been.
Figure 2 shows the changes in the core index compared to the changes in the overall CPI. Obviously the changes in prices other than energy and food have been significantly smaller than the changes in the overall index, but have been on an upward trend.
Figure 3 shows annual rates of inflation from the 1970s to now. Compared to the rates of inflation in the 1970s and much of the 1980s, the current rate of inflation is low. Few observers would describe the most recent rates as high, and they are not, when compared to those of the past thirty years. However, the last two years are above the average of a bit less than 2 percent in the previous three years. The recent core rates have also been increasing and that has caused some concern. See the most recent Federal Reserve case study and the exercises at the end of this case.
The Consumer Price Index
The seasonally adjusted consumer price index in October was 201.7. The price index was equal to 100 during the period from 1982 to 1984. The years of 1982 to 1984 are described as the base period. The appropriate interpretation of the index is that prices in the market basket of goods and services purchased by the typical consumer increased from the 1982-1984 period to October 2006 by 101.7 percent, that is from 100 to 201.7. A typical consumer good that cost one dollar in 1982 to 1984 now costs $2.02.
Inflation is announced and reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in October was 201.7, compared to 202.7 in September. The decrease in prices from September to October was (201.7 - 202.7) / 202.7 = -.005. That means a monthly deflation rate of .5 percent or five-tenths of one percent.
To convert this into an approximate annual rate, you can simply multiply by 12. This provides us an annual inflation rate of (-.5) (12) = - 6 percent.
|Month||Price Level||Monthly Inflation Rate|
How the CPI is Calculated
Assume that there are only three goods (instead of goods and services in over 200 categories in the actual calculation) included in the typical consumer's purchases and, in the base or the original year, the goods had prices of $10.00, $20.00, and $30.00. The typical consumer purchased ten of each good.
In the current year, the goods' prices are $11, $24, and $33. Consumers now purchase 12, 8, and 11 of each good.
The CPI for the current year would be the quantities purchased in the market basket in the base year (ten of each good) times their prices in the current year divided by the quantities purchased in the market basket in the base year times their prices in the base year.
Thus [(10 x $11) + (10 x $24) + (10 x $33)] / [( 10 x $10) + (10 x $20) + (10 x $30)] = $680 / $600 = 1.133. That is, prices in the current year are 1.133 times the prices in the original year. Prices have increased on average by 13.3 percent. The quantities are the base year quantities in both the numerator and the denominator.
By convention, the indexes are multiplied by 100 and reported as 113.3 instead of 1.133.
The base year index simply divides the prices in the base year (times the quantities in the base year) by the prices in base year (times the quantities in the base year). The base-year index then is 1.00; or multiplied by 100 equals 100.
How the CPI Data are Collected
he Bureau of Labor Statistics samples the purchases of households representing 87 percent of the population. The consumer price index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. Forty-one percent of the market basket is made up of goods that consumers purchase. The other fifty-nine percent includes services.
Goods and services sampled include food, clothing, housing, gasoline, other transportation prices, medical, dental, and legal services and hundreds of other retail goods and services. Taxes associated with the purchases are included. Each item is weighted in the average according to its share of the spending of the households included in the sample.
Almost 80,000 prices in 87 urban areas across the country are sampled by Bureau of Labor Statistics professionals. Visits and phone calls are made to thousands of households and thousands of retail stores and offices.
For more information on the Bureau of Labor Statistics, visit [EEL-link id='1216' title='www.bls.gov.' ]
A Market Basket of Goods and Services
The Consumer Price Index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. The relative importance of each of the categories of goods and services that included in the market basket are as follows:
|Housing 42%||Recreation 6%|
|Transportation 17%||Education and communication 6%|
|Food and beverages %15||Clothing 4%|
|Medical care 6%||Other good and services 4%|
CPI Interactive Exercise
Causes of Inflation
Over short periods of time, inflation can be caused by increases in costs or increases in spending. Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation. Increases in demand, particularly if production in the economy is near the full-employment level of real GDP, pull up prices. It is not just rising spending. If spending is increasing more rapidly than the capacity to produce, there will be upward pressure on prices.
Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation. Increases in costs push prices up. The most common recent examples are inflationary periods caused largely by increases in the price of oil. Or if employers and employees begin to expect inflation, costs and prices will begin to rise as a result.
Over longer periods of time, that is, over periods of many months or years, inflation is caused by growth in the supply of money that is above and beyond the growth in the demand for money.
Inflation, in the short run and when caused by changes in demand, has an inverse relationship with unemployment. If spending is rising faster than capacity to produce, unemployment is likely to be falling and demand-pull inflation increasing. If spending is rising more slowly than capacity to produce, unemployment will be rising and there will be little demand-pull inflation.
That relationship disappears when inflation is primarily caused by increases in costs. Unemployment and inflation can then rise simultaneously.
Other Measures of Inflation
The GDP price index (sometimes referred to as the implicit price deflator). The GDP price index is an index of prices of all goods and services included in the gross domestic product. The index is a measure that is broader than the consumer price index and is more appropriate to use in calculating real GDP than the CPI, which measures changes in consumer prices alone.
The producer price index. This index measures prices at the wholesale or producer level. It can act as a leading indicator of inflation facing consumers. If the prices producers are charging are increasing, it is likely that consumers will eventually be faced with higher prices for good they buy at retail stores.
A Note on Seasonally Adjusted and Unadjusted Data
"Because price data are used for different purposes by different groups, the Bureau of Labor Statistics publishes seasonally adjusted as well as unadjusted changes each month. For analyzing general price trends in the economy, seasonally adjusted changes are usually preferred since they eliminate the effect of changes that normally occur at the same time and in about the same magnitude every year--such as price movements resulting from changing climatic conditions, production cycles, model changeovers, holidays, and sales.
The unadjusted data are of primary interest to consumers concerned about the prices they actually pay. Unadjusted data also are used extensively for escalation purposes. Many collective bargaining contract agreements and pension plans, for example, tie compensation changes to the Consumer Price Index unadjusted for seasonal variation." ([EEL-link id='1271' title='www.bls.gov/cpi/cpisapage.htm' ])
Economists define the approximate unemployment rate, at which there are not upward or downward pressures on wages and price, as full employment rate of unemployment. If unemployment falls to level below the full employment rate, there will be upward pressure on wages and prices. If unemployment rises to a very high rate, there will downward pressure on wages and prices or wages and prices will remain steady. In the middle is a level, or more likely a range, where there is not pressure on wages and prices to rise or fall.
Economists do not know for certain what that unemployment rate is, and even if they did, it does change over time. A current consensus estimate is that the full employment rate of unemployment is currently between 4.5 and 5.0 percent of the labor force being unemployed. That is if unemployment were to fall to 4.0 percent of the labor force, there will increased upward pressure on wages and that may cause prices to begin to increase. If unemployment were 6 percent, workers competing for jobs may cause wages to fall. Costs of producing fall and prices may fall. Or at least not increase as rapidly.