INTRODUCTION

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 December 16, 2009, BLS press release of data on the consumer price index for the month of November, 2009.

TASK

  • 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.

PROCESS

The U.S. Bureau of Labor Statistics announcement: Consumer Price Index (CPI-U): November, 2009
Released December 16, 2009

"On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.4 percent in November, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months the index increased 1.8 percent before seasonal adjustment, the first positive 12-month change since February 2009."

The BLS noted that the rate of annual change in the CPI-U was positive for the first time since February. Late 2008 saw three monthly decreases in the CPI-U and early 2009 saw very small changes in most months. Fears of deflation - a sustained decrease in the price level - expressed by many in late 2008 have disappeared as economic growth appears to have returned.  

"The seasonally adjusted increase in the all items index was due to a 4.1 percent increase in the energy index. The index for gasoline rose sharply and the indexes for electricity, fuel oil, and natural gas also increased, creating the fourth consecutive rise in the energy index and the largest increase since August." A substantial portion of the overall price level increase in November was attributed to energy prices. Energy prices have risen more constantly recently after two years of irregular decreases and increases. Figure 1, below, shows the monthly changes in the CPI-U for selected product groups for the past six months and the annual change since November 2008. Note the significant changes in energy prices

Figure 1:  Monthly & 12 Month Changes in the CPI-U
  May June July Aug Sept Oct Nov 12 Months
Nov-Nov
All Items .1 .7 .0 .4 .2 .3 .4 1.8
   Food -.2 .0 -.3 .1 -.1 .1 .1 -.7
      Food at home -.5 .0 -.5 .0 -.3 .0 .0 -2.9
      Food away from home .1 .1 .1 .1 .1 .1 .2 2.1
   Energy .2 7.4 -.4 4.6 .6 1.5 4.1 7.4
      Gasoline (all types) 3.1 17.3 -.8 9.1 .2 1.6 6.4 23.6
       Fuel oil -3.3 4.8 -1.5 6.2 1.0 6.3 9.0 -6.9
       Electricity -.4 -1.9 -.6 -.1 1.5 .6 1.4 .1
All items less food & energy .1 .2 .1 .1 .6 .2 .0 1.7
New vehicles .5 .7 .5 -1.3 .2 1.6 .6 4.9
Used cars & trucks 1.0 .9 .0 1.9 1.6 3.4 2.0 5.8
Apparel -.2 .7 .6 -.1 .1 -.4 -.3 1.0
Services less energy services .1 .1 .0 .2 .1 .1 .0 1.4
      Shelter .1 .1 -.2 .1 .0 .0 -.2 .3
      Transportation Services -.1 -.1 .5 .6 .7 .4 .6 3.6
      Medical care services .3 .2 .3 .2 .4 .2 .4 3.5


The Core Rate of Inflation in November

The BLS also reported the "Core" rate of inflation - all items less food and energy. The core rate excludes these items because they are seen as historically more volatile.  Without the two items that tend to increase and decrease more greatly around the average, some see a more clear indicator of long-term inflation. 

"In contrast, the index for all items less food and energy was unchanged in November, after ten consecutive monthly increases. Declines in shelter indexes offset increases in the indexes for new and used motor vehicles, medical care, airline fares, and tobacco. The food index rose slightly in November. As in October, the food away from home index rose modestly while the index for food at home was unchanged. Within the latter, three grocery store food groups posted increases while three declined."

Selected Consumer Price Index Data for November 2009

Food

"The food index rose 0.1 percent in November, the same increase as in October. The index for food away from home increased 0.2 percent while the food at home index was unchanged. Among the food at home groups, the dairy and related products index declined 0.7 percent in November after rising 1.0 percent in October, and the index for other food at home also declined in November following an October increase. In contrast, the indexes for fruits and vegetables and for meats, poultry, fish, and eggs both increased in November after declining in October. The index for nonalcoholic beverages fell for the second straight month, declining 0.3 percent in November, and the index for cereals and bakery products rose 0.1 percent in November after being unchanged in October. Over the past year, the food index has declined 0.7 percent. The food at home index has fallen 2.9 percent over the last 12 months, with five of the six grocery store food groups declining, but the index for food away from home has risen 2.1 percent."

Energy

"The energy index rose 4.1 percent in November after increasing 1.5 percent in October. The index for energy commodities rose 6.3 percent, with the gasoline index increasing 6.4 percent. (Before seasonal adjustment, gasoline prices rose 4.1 percent in November.) The rise in the gasoline index accounted for over three-quarters of the total energy increase. The remainder of the increase was due to advances in all of the other energy components. The index for fuel oil rose 9.0 percent in November following a 6.3 percent increase in October. The index for energy services increased 1.4 percent in November, with the electricity index rising 1.4 percent and the index for natural gas advancing 1.5 percent. The energy index has risen 7.4 percent over the past 12 months, with the gasoline index rising 23.6 percent."

All items less food and energy

"The index for all items less food and energy was unchanged in November after rising 0.2 percent in October. The heavily weighted index for shelter, unchanged in October, declined 0.2 percent in November. Within the shelter group, the indexes for rent and owners’ equivalent rent both declined 0.1 percent and the lodging away from home index fell 1.5 percent. Also declining in November were the indexes for household furnishings and operations and for apparel, both down 0.3 percent. Several indexes posted increases to offset these declines. The new vehicles index rose 0.6 percent in November, its tenth increase in the last eleven months. The index for used cars and trucks advanced 2.0 percent in November and has now risen 11.1 percent since April. The index for airline fares rose 3.8 percent in November and has increased 13.3 percent since June. The medical care index increased 0.3 percent in November and the index for tobacco advanced 1.0 percent. Over the past 12 months, the index for all items less food and energy has risen 1.7 percent."

Not seasonally adjusted CPI measures

"The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.8 percent over the last 12 months to an index level of 216.330 (1982-84=100). For the month, the index increased 0.1 percent prior to seasonal adjustment."

"The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) increased 2.3 percent over the last 12 months to an index level of 212.003 (1982-84=100). For the month, the index increased 0.2 percent prior to seasonal adjustment."

"The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) increased 1.6 percent over the last 12 months. For the month, the index was unchanged on a not seasonally adjusted basis. Please note that the indexes for the post-2007 period are subject to revision."

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 116.33 percent.

Figure 2:  Consumer Price Index (CPI-U) Weights & Index Levels by Category (Nov 2009)

Spending Category

Weight*

Index Level

Food and beverage

15.8%

217.733

Housing

43.4%

215.808

Apparel

3.7%

122.645

Transportation

15.3%

188.587

Medical Care

6.4%

374.575

Recreation

5.7%

113.820

Education/Communication

6.3%

129.845

Other

3.4%

376.702

All Items

100%

216.330

*Weights established as of December 2009

* The "other" category includes items such as tobacco products, personal care products and services, and other personal services.

Connections to 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 3 illustrates four sets of macroeconomic data - CPI, unemployment, real GDP growth and the federal funds rate. 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 early 2009, as U.S. real GDP declined, the unemployment rate increased substantially.

Figure 3:  Selected Macroeconomic Data
1999-2009
Year Real GDP
Change
(annual)
Unemployment
Rate
(annual)
CPI-U
(annual)
Fed Funds
Rate Target
(March)
1999 4.5 4.2 2.2 4.75
2000 3.7 4.0 3.4 6.00
2001 0.8 4.3 2.8 5.00
2002 1.6 5.7 1.6 1.75
2003 2.6 5.9 2.3 1.00
2004 3.6 5.8 2.7 1.00
2005 2.9 5.2 3.4 2.75
2006 2.8 4.7 3.2 4.75
2007 1.0 4.4 2.8 5.25
2008 1.1 5.1 3.8 2.25
2009 -4.7* 8.5** 1.8*** -0.25

*Real GDP change data for 2009 is through the 3rd quarter.
**Unemployment is the montly average through November.
***CPI-U data is November 2009 through November 2009.


Business Cycles


Business cycles or periodic fluctuations in growth and employment illustrate the relationships of some data (see Figure 4). 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.

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 the 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.

CONCLUSION

The BLS reported that the seasonally adjuasted Consumer Price Index for All Urban Consumers (CPI-U) rose 0.4 percent in November and rose by 1.8 percent over the past 12 months before seasonal adjustment. This was the first positive 12-month change since February 2009.

Far from the fears of deflation that were heard in the depth of the recession (Q4 2008 and Q1 2009), the more recent increases in the CPI indicate that there are some pressures on prices to increase. This may be due to increased growth and increased demand for commodities and consumer products. Does it mean the end of the recession?

ASSESSMENT ACTIVITY

Next have your students answer a question on the below interactive notepad.

 


How important is it to adjust economic growth or income data for the effect of inflation?

EXTENSION ACTIVITY

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, 1995-2009."  Read the inflation data about the nine industrialized nations.

Go to, "U.S. Import and Export Price Indexes, March 2009 ."  Read about the price changes for U.S. imports and exports.