Return

Announcement

The consumer price index (CPI) during the month of January increased by .5 percent (one-half of one percent). The rate of increase in the consumer price index over the past twelve months has been 1.9 percent.

In January, the core consumer price index, which excludes energy and food prices, in creased by 0.2 percent. The core index has increased by 1.1 percent over the last twelve months.

Compared to the history of inflation in the U.S., is this rate of inflation particularly high, low, or just about equal to previous levels?

Current inflation is higher   Current inflation is about the same   Current inflation is lower
Table 1
Rate of Change in the Consumer Price Index
(fron December to December)
1994 1995 1996 1997 1998 Average 1994 to 2003 = 2.3%
2.6% 2.5% 3.3% 1.7% 1.6%
1999 2000 2001 2002 2003
2.7% 3.4% 1.6% 2.4% 1.9%

Definitions 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 measures the cost of a fixed set of goods relative to the cost of those same goods in a previous year. Changes in the prices of those goods approximate changes in the overall level of prices paid by consumers.

Data Trends

In January, the Consumer Price Index increased by .5 percent, after increasing .2 percent in December and falling by -.2 percent in November. In January, increases in transportation costs and housing costs were largely responsible for the overall decrease. In fact, increases in prices of energy accounted for almost three-quarters of the increase. The prices of medical care also increased during the month.

The .5 percent increase is the most rapid monthly increase in prices in almost one year. However the increase over the last 12 months remains rather mild.

The core rate of inflation (.2 percent in January) represents 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 January increase compares to a 0.1 percent increase in the core rate of inflation in December and no change in November. Core prices increased more slowly than the overall index due to the importance of the rapid rise in prices of energy.

Figure 1: Monthly Inflation in Consumer Prices at Annual Rates

Figure 1 shows recent inflation data reported for each month. It is obvious that the monthly inflation figures change a great deal and that rates of inflation are not exactly stable from one month to the next.

Figure 2: Monthly Core Inflation Rate (excludes food and energy) at Annual Rates

Figure 2 shows what happens to those numbers when averages over three month periods are reported instead of the inflation rates for a single month. Inflation increased in 1999 and 2000 when compared to1998, fell throughout muc

h of 2001, and then has increased in 2002. What is really quite obvious from Figure 2 is that the changes in inflation from month to month, even reporting the three-month averages, are much more dramatic from 2001 on, when compared to 1998, 1999, and 2000. The increased volatility is primarily due to fluctuations in the prices of oil and food. The core rate of inflation (excluding food and energy) gives a much better idea of longer-term trends and that is why it is often featured in news reports. See figure 3.

Figure 3: Inflation in Consumer Prices since 1970

Compared to the rates of inflation in the 1970s and much of the 1980s, the current rate of inflation is quite low. See figure 4 below. Few observers would describe the most recent rates as high and they are not, when compared to those of the past thirty years. Other observers would describe the current experience as no or zero inflation.

Figure 4: Inflation in Consumer PRices Since 1970

The Consumer Price Index

The seasonally adjusted consumer price index in January was 185.8. The price index was equal to 100 during the period from 1982 to 1984. The interpretation is that prices in market basket of goods purchased by the typical consumer increased from the 1982-1984 period to January 2004 by 85.8 percent.

Inflation is usually reported in newspapers and television news as percentage changes in the CPI on a monthly basis. For example, the CPI in January was 185.8, compared to 184.9 in December. The increase in prices from December to January was (185.8-184.9) / 184.9 = 0.0049 or a monthly inflation rate of .49 percent. It is reported to the nearest one-tenth of a percent, in this case, .5 percent. To convert this into an annual rate, you could simply multiply by 12. This approximates an annual inflation rate of (.5) (12) = 6.0 percent. A slightly more accurate measurement of the annual inflation rate is to compound the monthly rate, or raise the monthly rate of increase, plus one, to the 12th power, which in this case give the same result.

How the Annual Inflation Rate is Calculated

Month

Price Level

Monthly Inflation Rate

Annual Inflation Rate

January 185.8
185.8-184.9

= .0049 or .5 %


184.9

1.004912 = 1.06
or 6% increase in prices

December 184.9

Deflation

Deflation is a fall in prices. Most observers would describe the current rate of change in prices as practically no inflation or, at least, such a low rate of inflation that it is not a serious problem. With inflation so low, it is not surprising to experience a negative rate of inflation (or deflation) in some months. October and November of 2003 were recent months were the CPI actually declined.

If prices were to fall on a continual basis, it is not as good news as one might initially think. If consumers expect prices to fall, many may put off purchases until prices are lower. This decrease in overall demand may contribute to further downward pressure on prices and to further reductions in spending. It is certainly possible, but not likely under current conditions, to experience such an event in the U.S.

How the CPI Data are Collected

"The Consumer Price Index (CPI) is a measure of the average change in prices over time of goods and services purchased by households. The CPI is based on prices of food, clothing, shelter, and fuels, transportation, fares, charges for doctors' and dentists' services, drugs, and other goods and services that people buy for day-to-day living.

“Prices are collected in 87 urban areas across the country from about 50,000 housing units and approximately 23,000 retail establishments - department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments. All taxes directly associated with the purchase and use of items are included in the index. Prices of fuels and a few other items are obtained every month in all 87 locations.

“Prices of most other commodities and services are collected every month in the three largest geographic areas and every other month in other areas. Prices of most goods and services are obtained by personal visits or telephone calls of the Bureau's trained representatives.” For more information on the Bureau of Labor Statistics, visit ( [EEL-link id='1216' title='www.bls.gov' ]).

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.

Causes of Inflation

To understand causes of inflation, think of individual markets. What might cause prices to increase if we observe that prices are rising in most markets?

Increase in supply   Increase in demand   Decrease in supply   Decrease in demand

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 more slowly than capacity to produce, unemployment will be rising and there will be little demand-pull inflation. If spending is rising faster than capacity, unemployment is likely to be falling and demand-pull inflation increasing.

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. Thus the index is a measure that is broader than the consumer price index.
The producer price index.
This index measures prices at the wholesale or producer level. It can act as a leading indicator of inflation. 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.