This lesson focuses on the Consumer Price Index (CPI) and U.S. rate of inflation reported September 15, 2011, by the U.S. Bureau of Labor Statistics (BLS) for the month of August, 2011. Students read the BLS report, analyze the meaning of the CPI data, determine the change in consumer prices, and explore the impact of the change in the price level on themselves, their families, consumers, and producers.
- Identify the current rate and recent changes in the CPI and rate of inflation in the United States for the month of August, 2011.
- Identify factors that have influenced recent changes in the CPI.
- Describe how inflation impacts different groups in the economy.
- Distinguish between the reported CPI, the core rate, and other measures of inflation.
Current Key Economic Indicatorsas of November 30, -0001
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 September 15, 2011, BLS press release of data on the consumer price index for the month of August, 2011.
[NOTE: You can subscribe to receive monthly BLS email news releases. To subscribe, go to the BLS News Service Subscription Page. www.bls.gov/bls/list.htm ]
[NOTE on the CPI and Inflation "Focus on Economic Data" Lessons: During the first semester of the 2011-2012 school year (September-December, 2011), EconEdLink will publish four lessons on "Consumer Price Index and Inflation." During this time period, the Focus on Economic Data will begin with the "basics" in September and progressively focus on more complex data, issues, and comparisons. All monthly lessons will include the current data and significant recent changes.
September: CPI and inflation (deflation) basics: What is the CPI? What is inflation and deflation? How are they measured? What do they mean?
October: Details and issues about the measurements and meaning of the measurements of the price level, adding additional concepts. March: Detailed breakdown of the data by region and other criteria (trends, identifying trends and comparisons of regions and demographic groups).
November: U.S. regional and global price level and inflation comparisons.
- December: The relationships of CPI and inflation data to other economic data, such as GDP, employment. etc. and the business cycle. End of year price level summary and potential issues.
BLS release of CPI data: Released on September 15, 2011, for the month of August, 2011.
BLS "Focus on Spending and Prices": These quarterly reports highlight recent trends in inflation and spending in the U.S. economy.
"The Consumer Price Index.": This article is from the BLS Handbook of Methods, Chapter 17. It talks in great depth about the CPI.
Frequently Asked Questions About the CPI: This site answers FAQ's for those trying to read CPI releases.
CPI Inflation Calculator: This calculator allows users to compare price changes over time due to inflation.
EconomicIndicators.gov: This site provides the latest updates on U.S. economic indicators.
BLS Economic Indicators: This site provides the latest updates on U.S. economic indicators.
Whose Buying Habits Does the CPI Reflect?: This page explains that the BLS measurement of the CPI-U includes all urban consumers, representing about 87 percent of the total U.S. population.
Consumer Price Index for all Urban Consumers: U.S. City Average, by Expenditure Category and Commodity and Service Group. This table explains the current level of the CPI-U.
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-though within the PPI.
Frequently Asked Questions
Key Economic Indicatorsas of September 15, 2011
On a seasonally adjusted basis, the CPI-U increased 0.4 percent in August (2011) after increasing 0.5 percent in July. The index for all items less food and energy rose 0.2 percent in August, the same increase as in July.
The number of unemployed persons in the U.S., at 14.0 million, was essentially unchanged in August, and the unemployment rate held at 9.1 percent.
Real gross domestic product increased at an annual rate of 1.0 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter). In the first quarter, real GDP increased 0.4 percent.
FOMC Statement: "To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."
On September 15, 2011, the U.S. Bureau of Labor Statistics (BLS) reported that the U.S. seasonally adjusted consumer price index for all urban consumers (CPI-U) increased by 0.4 percent in August, 2011. The BLS also reported that the "core" CPI, minus food and energy prices, increased just 0.2 percent in August.
What's the difference? How much "inflation" did the U.S. really experience in August 2011? Read more and find out. You decide which is the more appropriate measurement of inflation?
[Teacher Note: Challenge your students to determine what they think is the best measurement of inflation as they complete the CPI lesson.]
What is the Consumer Price Index?
The Consumer Price Indexes (CPI), reported by the U.S. Bureau of Labor Statistics, part of the U.S. Department of Labor, is a monthly measurement of changes in the prices paid by urban consumers for a representative market basket of goods and services. An increase in the CPI from one month to another over time may be evidence of "inflation" in the price level or a reduction in purchasing power.
The CPI measures changes in prices over time. By selecting an appropriate base year and setting the index level for that time period at 100, the CPI compares one month's price index level with the base year or any other time period. The current standard reference base period is the average of the period from 1982 to 1984.
To see how the CPI works, you can go to the BLS CPI Calculator. The CPI inflation calculator allows you to calculate the value of current dollars in an earlier period, or to calculate the current value of dollar amounts from years ago. Consumer Price Indexes often are used to escalate or adjust payments for rents, wages, alimony, child support and other obligations that may be affected by changes in the cost of living.
[Teacher Note: You can assign the students different time periods to determine the rates of inflation over those time periods. Link: http://data.bls.gov/cgi-bin/cpicalc.pl ]
What is Inflation?
Inflation is generally defined (by the BLS) as a continual increase in the overall level of prices. It is an increase in average prices that lasts at least a few months. Often, a one month increase in prices is referred to as inflation, but a longer-term upward trend of prices is a more accurate definition. The most widely reported measurement of inflation is the Consumer Price Index (CPI). For this announcement, the BLS reports the CPI-U - the consumer price index for all urban consumers.
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. This group of goods and services is often referred to as the "market basket." Changes in the prices of those goods and services approximate changes in the overall level of prices paid by consumers. If the price level of consumer goods and services increases over a period of time, the consumer's purchasing power decreases (assuming, of course, that the consumer's disposable income and spending pattern remain the same).
Just the opposite of the definition of inflation, deflation is generally defined as a continual decrease in the overall level of prices. It is a decrease in average prices that lasts at least a few months. If the price level of consumer goods and services decreases over a period of time, the consumer's purchasing power increases (assuming, again, that the consumer's disposable income and spending pattern remain the same.
Discussion Question: Is this definition what you thought inflation was?
[Teacher Note: BLS web page article Frequently Asked Questions About the CPI provides information for this discussion.]
Consumer Price Index and Inflation - August- 2011
Bureau of Labor Statistics Announcement, September 15, 2011
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in August on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.8 percent before seasonal adjustment."
In each announcement, the BLS will comment on any items that significantly affected the overall CPI change, very often referring to the impact of energy price changes. "The seasonally adjusted increase in the all items index was broad-based, with continuing increases in the indexes for gasoline, food, shelter, and apparel. The gasoline index rose for the 12th time in the last 14 months and led to a 1.2 percent increase in the energy index, while the food index rose 0.5 percent, its largest increase since March."
The Core CPI
The BLS also reports the "core" CPI, a measure that excludes food and energy prices. "The index for all items less food and energy increased 0.2 percent in August, the same increase as the previous month. Shelter and apparel were the biggest contributors, though the indexes for most of its major components posted increases, including used cars and trucks, medical care, household furnishings and operations, recreation, tobacco, and personal care. The new vehicles index, unchanged for the second month in a row, was an exception."
Annual CPI Change
The annual rate of change in the CPI is also reported by the BLS. "The 12-month change in the all items index edged up to 3.8 percent after holding at 3.6 percent for three months, while the 12-month change for all items less food and energy reached 2.0 percent for the first time since November 2008. The energy index has risen 18.4 percent over the last year, while the food index has increased 4.6 percent."
[Teacher Note: A brief explanation of seasonal adjustment from the BLS: “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 before adjustment for seasonal variation.” Source: BLS, When Should I use Seasonally Adjusted Data?
[Teacher Note: For student discussion, ask: What price changes have you noticed over the previous few months? Gasoline? Food? Other consumer goods? What about housing or rent?]
Discussion Question: How has inflation affected you over the past few months? Are you paying more for the goods and services you buy?
What was the Nominal Level of the CPI-U in August 2011?
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 3.8 percent over the last 12 months to an index level of 226.545 (1982-84=100)." The "market basket" of goods and services that cost $218.31 in August of 2010, cost $226.55 in August of 2011. That's about $8 more for the basket of goods and services over the course of the last year.
The BLS also reports the CPI-W, a price level measurement for "urban wage earners and clerical workers." What's the difference? The BLS "FAQs" webpage explains:
“The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers. The all urban consumer group represents about 87 percent of the total U.S. population. It is based on the expenditures of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. Not included in the CPI are the spending patterns of people living in rural nonmetropolitan areas, farm families, people in the Armed Forces, and those in institutions, such as prisons and mental hospitals.”
“The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is based on the expenditures of households included in the CPI-U definition that also meet two requirements: more than one-half of the household's income must come from clerical or wage occupations, and at least one of the household's earners must have been employed for at least 37 weeks during the previous 12 months. The CPI-W population represents about 32 percent of the total U.S. population and is a subset, or part, of the CPI-U population.”
Because the CPI-W represents a more clearly defined segment of the "average" urban working population, it is more often used in labor negotiations.
"The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) increased 4.3 percent over the last 12 months to an index level of 223.326 (1982-84=100). For the month, the index increased 0.3 percent prior to seasonal adjustment." The price level for "wage earners" is slightly higher than for "all urban consumers."
The third CPI measurement reported monthly is the C-CPI-U, a "chained" price index. According to the BLS, the advantage of the C-CPI-U is that it uses a formula that includes "expenditure data in adjacent time periods in order to reflect the effect of any substitution that consumers make across item categories in response to changes in relative prices. The new measure is designed to be a closer approximation to a "cost-of- living" index than the existing BLS measures." In other words, it more accurately reflects actual consumer decisions, especially substitution, over shorter time periods.
"The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) increased 3.6 percent over the last 12 months. For the month, the index increased 0.3 percent on a not seasonally adjusted basis."
[Teacher Note: To review the recent history of the CPI-U from 1990 to the present time, go to the BLS webpage: http://data.bls.gov/cgi-bin/surveymost .]
Real vs. Nominal Data Measurements
In many cases, data should be adjusted for a change in the price level to make comparisons over time more meaningful. The term "nominal" is used to refer to a measurement in current dollars. To adjust for inflation and determine a "real" value, the nominal value is adjusted by the price level change. A measurement such as gross domestic product in nominal terms refers to the measurement at current dollars (prices.) To compare GDP in two years, the rate of inflation between the years must be subtracted to determine the real change.
The same is true for income and purchasing power. Suppose Mr. Jones made $50,000 in 2009 and $52,000 in 2010. His income increased by $2,000 or 4 percent from 2009 to 2010. If the rate of inflation between 2009 and 2010 was 5 percent, Mr. Jones' purchasing power actually decreased by 1 percent. His 4 percent increase in income did not purchase the same amount of goods and services as it did in the previous year. Inflation reduced his purchasing power.
[Teacher Note: Emphasize the meaning of "real income" or "real GDP" as measurements of value adjusted for inflation and the importance of adjusting for inflation when making comparisons over time.]
The CPI Market Basket
The CPI market basket represents all the consumer goods and services purchased by urban households. Price data are collected for over 180 categories, which BLS has grouped into 8 major groups. These major groups, with examples of categories in each, are as follows:
- Food and beverages (ham, eggs, carbonated drinks, coffee, meals and snacks)
- Housing (rent of primary residence, fuel oil, bedroom furniture)
- Apparel (men’s shirts and sweaters, women’s dresses, jewelry)
- Transportation (new vehicles, gasoline, tires, airline fares)
- Medical care (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)
- Recreation (television sets, cable TV, pets and pet products, sports equipment, admissions)
- Education and communication (college tuition, postage, telephone services, computer software and accessories)
- Other goods and services (tobacco and smoking products, haircuts and other personal care services, and funeral expenses)
Discussion Question: How important are the above categories in your personal "market basket"?
Figure 1, below, shows the August 2011 price level data for the primary categories in the CPI-U "market basket," including the relative importance (weight) of each category, the category price index level in December, and the percentage changes from the past month and year.
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||0.4||3.8|
|Food at home||0.6||0.6||6.0|
|Food away from home||0.2||0.4||2.7|
|Gasoline (all types)||4.7||1.9||32.4|
|Fuel oil (1)||-1.7||-0.4||35.4|
|Utility (piped) gas service||-1.2||2.2||-2.0|
|All Items Less Food and Energy (core)||0.2||0.2||2.0|
|Commodities Less Food and Energy||0.3||0.4||2.1|
|Used Cars and Trucks||0.7||0.9||5.4|
|Medical Care Commodities (1)||0||0.1||3.0|
|Service Less Energy Services||0.2||0.2||1.9|
|Medical Care Services||0.3||0.3||3.3|
|(1) Not seasonally adjusted.|
[NOTE: The above data are national averages. The category weights differ from region to region. For instance, when the weight for food and beverage was 15.4 in the Boston region, it was 16.0 in the Cincinnati region. Food and beverage costs are a slightly larger portion of the market basket of the index in Cincinnati than in Boston.]
The CPI is a weighted average, meaning that each category of spending has a different weight or importance in the index - as it is with a consumer's spending. A typical consumer spends much more on housing than on food or entertainment. Thus, the impact of a change in housing prices impacts the consumer's budget much more than a change in food or entertainment prices. Those who spend much more of their income on gasoline will be impacted more by a rise in oil prices. Figure 2, below, shows the relative weights of the major spending categories in the determination of the CPI.
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 2010.|
[Teacher Note: It may be interesting for students to determine their own "market basket." How do they spend their income? What percentages of their income (weights) do they spend on gasoline, clothes, entertainment., etc.?]
Recent History of the CPI-U
Figure 3, below, shows the monthly changes in the CPI-U price level from 2002 through August, 2011. Note the several periods of higher inflation, the periods of stability, and the short periods of lower prices. The key variable over this time has been the increases and decreases in energy prices, especially gasoline.
Measuring Consumer Prices
There are several measurements or reported levels of the CPI. They are:
- CPI: A measure of the average change in prices over time of goods and services purchased by households.
- CPI-U: The Consumer Price Index for All Urban Consumers. This includes approximately 87 percent of the total population, including wage earners and clerical worker households, groups such as professional, managerial, and technical workers, the self-employed, short-term workers, the unemployed, retirees, and others not in the labor force.
- CPI-W: The Consumer Price Index for Urban Wage Earners and Clerical Workers. This includes households of wage earners and clerical workers, representing approximately 32 percent of the total population.
- C-CPI-U: The Chained Consumer Price Index for All Urban Consumers. This measurement uses a formula that reflects the substitutions consumers make in response to changes in relative prices.
- Core CPI: The average price of the same set of goods and services, without some of the more volatile components, such as food and energy prices.
How is the CPI 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, $20, and $30. The typical consumer purchased ten of each good. Total cost of this "market basket" in the base year was $600.
In the current year, the three goods' prices are $11, $24, and $33. Consumers now purchase 12, 8, and 11 of each good. The total current price of this "market basket" is $622, but this would not be an accurate way to compare the "price level." An accurate comparison has to assume a constant pattern of purchasing.
The determination of the CPI for the current year uses 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
The 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.
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.
Demand-pull example: If the economy and the population are growing at a fast pace, food and energy supplies may not be increasing fast enough. Prices will rise because of the "pull" of increased demand.
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.
Cost-push example: If OPEC and other oil producers restrict their output, oil prices will rise. Because oil is an important resource for the production of many consumer goods, the prices of those goods will rise because of the increased cost of production.
[Teacher Note: Examples]
If the companies raise their prices for the products they produce because the costs of the raw materials they use, such as petroleum, iron ore, other commodities, increase, the economy may be experiencing cost-push inflation.
If the demand for some good and services exceeds the supply and consumers "bid" more to purchase the product, the economy may be experiencing demand-pull inflation.]
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.
The Costs of Inflation
Understanding the costs of inflation is not an easy task. There are a variety of myths about inflation. There are debates among economists about some of the more serious problems caused by inflation.
High rates of inflation mean that people and business have to take steps to protect their financial assets from inflation. The resources and time used to do so could be used to produce goods and services of value. Those goods and services given up are a true cost of inflation.
High rates of inflation discourage businesses planning and investment as inflation increases the difficulty of forecasting of prices and costs. As prices rise, people need more dollars to carry out their transactions. When more money is demanded, interest rates increase. Higher interest rates can cause investment spending to fall, as the cost of investing increases. The unpredictability associated with fluctuating interest rates makes customers less likely to sign long-term contracts as well.
The adage "inflation hurts lenders and helps borrowers" really only applies if inflation is not expected. For example, interest rates normally increase in response to anticipated inflation. As a result, the lenders receive higher interest payments, part of which is compensation for the decrease in the value of the money lent. Borrowers have to pay higher interest rates and lose any advantage they may have from repaying loans with money that is not worth as much as it was prior to the inflation.
Inflation reduces the purchasing power of money. If your income is fixed or does not increase as much as the rate of inflation, you cannot purchase as many goods and services this year as you could last year. Your real income decreases.
On average, individuals' incomes do increase as inflation increases. However, some peoples' wages go up faster than inflation. Other wages are slower to adjust. People on fixed incomes such as pensions or whose salaries are slow to adjust are negatively affected by unexpected inflation.
Inflation redistributes income. Those who owe money (borrowers) can repay it with inflated dollars (if their income increased to keep up with the inflation). Those who are owed money (lenders) receive dollars with less value when loans are repaid. Hopefully, the principal and interest received have at least the same purchasing power as the money loaned. In this situation, income is redistributed from lenders to borrowers.
Discussion Question: How does inflation affect the people you know - your parents, the elderly, your school, etc.?
Other BLS Price Indexes
The Bureau of Labor Statistics publishes several other price indexes which can be used by consumers, government agencies and, private companies for budgeting and planning.
- Producer Price Indexes The Producer Price Indexes (PPIs) are a family of indexes that measure changes in the selling prices received by domestic producers of goods and services. They formerly were referred to as Wholesale Price Indexes. When the PPIs are released, the news media will most often report the percentage change in the index for Finished Goods. Producer Price Indexes also can be used in escalation contracts. A fact sheet named Escalation Guide for Contracting Parties further explaining the PPI details is available.
- Import and Export Prices The International Price Program measures change in the prices of imports and exports of nonmilitary goods between the United States and the rest of the world.
- Employment Cost Trends This program publishes quarterly statistics that measure change in labor costs (also called employment costs or compensation costs) over time; quarterly data measuring the level of costs per hour worked are also published. Indexes are available for total labor costs, and separately for wages and salaries and for benefit costs. Some information is available by region, major industry group, major occupational group, and bargaining status.
- Contract Escalation Consumer Price Indexes, Producer Price Indexes, and the Employment Cost Index may be used to escalate contracts.
- Consumer Price Indexes (CPIs) Consumer Price Indexes as published by individual countries, unadjusted for comparability, as well as harmonized indexes for a smaller selection of countries, are available on the International Labor ComparisonsTables page.
[Teacher Note: Click on the underlined terms to see the BLS definitions.]
Short Answer Essay Questions:
1. What is the different between demand-pull and cost-push inflation?
[Demand pull inflation results from increased demand for goods and services. Cost push inflation results from rising prices for productive resources. If commodity prices force producers to raise the prices of consumer products, that is an example of 'cost push.' If population increase and other factors result in a greater number of people wanting a product, it may be an example of 'demand pull.']
2. Which measurement, the CPI-U or the core rate is the most meaningful measurement of inflation?
[Those concerned with the prices they currently pay for all goods and services, including energy and food, may see the CPI-U as more important. These are prices actually paid from one time to another. Consumers will typically base their spending plans on prices they currently pay or expect to pay. Inflation creates uncertainty about future purchasing power. Policy planners may look more at the core rate because energy and food prices have tended to go up and down over time, even if the longer term trend is upward. Planners must, necessarily, look at longer trend periods.]
3. Explain how a borrower can actually benefit from inflation?
[Assuming that the borrower’s income rises with the inflation, the borrower is repaying a loan with cheaper dollars. Suppose she earned $10 an hour in year 1 and borrowed $100 for one year at 5 percent interest. In year 2, her income increased to $11 an hour. If she repaid the loan in year 2 ($100 plus $5 interest), it took her fewer hours to earn the income to repay the loan. Her income inflated, but her debt did not – even with the 5 percent interest.]
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in August on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 3.8 percent before seasonal adjustment."
Consumer prices increased at an annualized rates of 4.8 percent in August - the annualized rate in this example is determined by assuming that the monthly rate of change remains constant and is multiplied by 12 months. Is a 4.8 percent annual increase in the price level significant? It depends on several factors.
- Did your income increase during this time period?
- What are your spending habits? Are they similar to the "market basket."
- Were energy prices a significant factor in August? Will the energy prices continue to increase or will they decrease in the coming months?
- What's happening in the economy? Growth? Decline? More employment? Continued high unemployment?
Watch the BLS announcements of prices and employment, plus the BEA real GDP growth announcements, over the next few months to get a better picture of the longer-term health of the U.S. economy.
Critics of the BLS measurement of the CPI argue that the current measurement process of the CPI-U has flaws that affect the meaning of the numbers and their impact on consumers. For instance, the CPU-U measures only urban consumer prices. They say that the CPI-U does not adequately account for changes in spending patterns over time, substitutions, and quality changes. Is the CPI-U, as currently measured, meaningful?
Is CPI an accurate assessment of the cost of living? An article in the August, 2008, "Monthly Labor Review," addresses "Common Misconceptions about the Consumer Price Index: Questions and Answers " The BLS web page has a summary of the article.
[Teacher Note: Students can read the summary and discuss whether or not the CPI is a meaningful measurement of cost of living.]