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This lesson focuses on the Consumer Price Index (CPI) and rate of inflation reported December 16, 2008, by the U.S. Bureau of Labor Statistics (BLS) for the month of November, 2008. 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.

KEY CONCEPTS

Causes of Inflation, Deflation, Inflation, Monetary Policy, Price, Price Stability, Real vs. Nominal

STUDENTS WILL

  • Identify the current rate and recent changes in the consumer price index.
  • Identify factors that have influenced recent changes in the inflation rate.
  • Identify the potential policy implications for the current economic conditions, including deflation.
  • Describe how inflation and deflation impact individuals, families and different groups in the economy.

Current Key Economic Indicators

as of November 10, 2014

Inflation

The Consumer Price Index for All Urban Consumers increased 0.1 percent in October on a seasonally adjusted basis. The core inflation rate increased the same amount. For the previous 12 months, the index increased 1.7%, the same rate as reported in the September report.

Employment and Unemployment

According to the October report of the Bureau of Labor Statistics, the unemployment rate fell from 5.9% to 5.8%, and the number of individuals unemployed also decreased. Total nonfarm employment rose by 214,000 in October. Employment gains were concentrated in retail trade, food services and health care.

Real GDP

The advance estimate for real GDP growth in the third quarter of 2014 was 3.5%, a decrease from the revised second quarter growth of 4.6%. Inventory investment reduced third quarter growth, while it added to second quarter growth. In addition, consumer spending increased at a lower rate in the third quarter, compared to the second. Finally, business investment increased in the third quarter, but at a lower rate than in the second quarter.

Federal Reserve

The FOMC believes that the labor market has shown considerable improvement and the risks of inflation rising above its 2% target are low. Therefore, the Federal Reserve announced plans to end its purchase of financial assets. In addition, the federal funds rate will remain at its current low level. However, the FOMC has signaled its willingness to increase the federal funds rate if inflation shows signs of rising above the 2% target.

INTRODUCTION

Each month, the U.S. Bureau of Labor Statistics (BLS) releases an estimate of 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.


U.S. Bureau of Labor Statistics Announcement, December 16, 2008: Consumer Price Index: November 2008

"The Consumer Price Index for All Urban Consumers (CPI-U) decreased 1.9 percent in November, before seasonal adjustment, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The November level of 212.425 (1982-84=100) was 1.1 percent higher than in November 2007."

"The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) decreased 2.3 percent in November, prior to seasonal adjustment. The November level of 207.296 (1982-84=100) was 0.7 percent higher than in November 2007."

"The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) decreased 2.0 percent in November on a not seasonally adjusted basis. The November level of 122.284 (December 1999=100) was 0.7 percent higher than in November 2007."

"On a seasonally adjusted basis, the CPI-U decreased 1.7 percent in November, the second consecutive record decrease. For the 12 month period ending in November the CPI was up 1.1 percent, compared to 5.6 percent for the twelve months ending July of this year."

[Note to teahcer: You can visit the BLS News Service Subscription Page and subscribe to receive monthly BLS email news releases.]

RESOURCES


Key Economic Indicators

as of December 16, 2008

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) decreased 1.9 percent in November 2008, before seasonal adjustment. The November level of 212.425 (1982-84=100) was 1.1 percent higher than in November 2007.

Employment and Unemployment

U.S. Nonfarm payroll employment decreased by 533,000 jobs in November and the unemployment rate rose from 6.5 to 6.7 percent.

Real GDP

U.S. real gross domestic product decreased at an annual rate of 0.5 percent in the third quarter of 2008,(preliminary estimate). In the second quarter, real GDP increased 2.8 percent.

Federal Reserve

At its December 16, 2008 meeting, the FOMC decided to reduce the target for the federal funds rate to a range of 0 to 1/4 percent.

PROCESS

Is It Deflation?

When the general price level decreases, goods and services are less expensive and consumers' purchasing power increases. If this occurs over time, economists call it "deflation." Just as inflation (rising prices over time) decreases consumers' purchasing power (taking more dollars to purchase the same goods and servies), deflation means that it takes fewer dollars to purchase the same goods and services.

It sounds like deflation is a good thing. For individuals who are purchasing goods and services, it may be a good thing. Their real wages increase and they can buy more or save more. With the same income, they can satisfy more of their wants.

For producers, deflation may have negative effects. Here is one possible scenario. As prices fall, businesses will seek to reduce wages. Because wages cannot be reduced very quickly, business may have to increase debt to cover production costs. If businesses with debt must lower their prices, their revenues decrease and it is harder to make loan payments. At the same time, businesses may curtail spending. They may have to reduce staff size. Reducing the number of jobs will reduce incomes and negatively impact consumer spending (aggregate demand). This period of deflation comes during a time when the U.S. and other economies are experiencing wide-spread problems.

Here's another potential problem with deflation. Suppose Mr. Jones borrowed $150,000 for a mortgage at 6% interest and he agreed to make monthly principal payments of $800. With this income, he can make the payments and live comfortably. Suppose Mr. Jones' income is reduced because his employer had to reduce product prices. He still has to make the $800 fixed mortgage payments. What if, because product prices are falling, Mr. Jones loses his job completely? Although other prices are falling, Mr. Jones fixed mortgage payments now take more of his real income.

Just as inflation makes it more difficult to plan for spending, saving and investment, deflation also makes planning difficult. Deflation can cause consumers and businesses to reduce spending further, slowing economic activity and further reducing demand.

Ideally, an economy can operate much more smoothly with a stable price level. Even anticipated inflation, at a low or moderate rate, can be factored into planning, interest rates, purchases, etc. The kind of deflation the U.S. has experienced in the last couple of months makes planning much more difficult and inhibits growth.

In recent years, the number one "enemy" of the Federal Reserve has been inflation. Interest rates have been raised and lowered to keep the price level stable. Recently, extraordinary measures have been taken by the Federal Reserve and the U.S. Treasury to pump liquidity into the economy - to counter the recessionary forces. Typical theory says that these increases in liquidity and the money supply can be inflationary. Not in a time when other economic forces have driven down GDP, reduced the number of jobs and created such uncertainty for producers and consumers. Can it be that a little inflation is a better problem to have than deflation?

Figure 1 shows the monthly changes in the Consumer Price Index form 2002 to the present. Note that there have been several brief periods of price declines. The current deflation is generally projected to extend somewhat longer. Certainly, the recent CPI decrease has been at a much greater level.

Inflation Figure 1


About the Consumer Price Index

The following is from the BLS online publication, "Frequently Asked Questions About the CPI ."

The CPI is a lot more complicated than just a measurement of "inflation."

"The Consumer Price Index (CPI) is a measure of the average change in prices over time of goods and services purchased by households. The Bureau of Labor Statistics publishes CPIs for two population groups:

  1. The CPI for Urban Wage Earners and Clerical Workers (CPI-W), which covers households of wage earners and clerical workers that comprise approximately 32 percent of the total population, and
     
  2. The CPI for All Urban Consumers (CPI-U) and the Chained CPI for All Urban Consumers (C-CPI-U), which cover approximately 87 percent of the total population and include in addition to wage earners and clerical worker households, groups such as professional, managerial, and technical workers, the self-employed, short-term workers, the unemployed, and retirees and others not in the labor force."

The CPI is really only applicable to the urban population. The BLS adds, "The CPIs are based on prices of food, clothing, shelter, and fuels, transportation fares, charges for doctors' and dentists' services, rugs, 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."

What is the "Index"?

The BLS explains, "The index measures price change from a designed reference date. For the CPI-U and the CPI-W the reference base is 1982-84 equals 100.0. The reference base for the C-CPI-U is December 1999 equals 100. An increase of 16.5 percent from the reference base, for example, is shown as 116.5. This change can also be expressed in dollars as follows: the price of a base period market basket of goods and services in the CPI has risen from $10 in 1982-84 to $11.65."

The BLS announcement included this information about the how index changes are calculated.

"Movements of the indexes from one month to another are usually expressed as percent changes rather than changes in index points, because index point changes are affected by the level of the index in relation to its base period while percent changes are not. The example below illustrates the computation of index point and percent changes.

Percent changes for 3-month and 6-month periods are expressed as annual rates and are computed according to the standard formula for compound growth rates. These data indicate what the percent change would be if the current rate were maintained for a 12-month period."

 

Index Point Change
CPI 202.416
Less Previous index - 201.800
Equals index point change = .616
Percent Change
Index point difference .616
Divided by the previous index / 201.800
Equals =0.003
Results multiplied by 100 0.003*100
Equals percent change = 0.3

 

[Note to teachers: For further details visit the Consumer Price Index home page.]

Breaking Down the Inflation Data

The BLS "inflation" announcement breaks down the changes in the price level by spending category. Analysis of the breakdown raises other questions about the meaning of data.

  1. How are different people affected by the price level changes?
  2. Are all industries impacted in the same way?
  3. Are lower gasoline prices good or bad for the overall economy? (Or, do lower gasoline prices just reflect other problems in the economy?)

[Note to teachers: The student version of this focus on economic data does not include some of the details about each spending category that are included in the section below.]

  • ENERGY - "The energy index fell 17.0 percent in November. The decrease was about twice the October decline and energy prices are now 32.4 percent below the July peak earlier this year. The gasoline index fell 29.5 percent in November and gas prices are now 47.0 percent below their July peak. The natural gas index also declined in November, the fourth consecutive decrease. After seasonal adjustment, the index was down 21.7 percent from July to November."

    Energy prices fell 17%, accounting for the vast majority of the total decrease in the price level. The BLS also reports what is called the "core" inflation rate - a measurement of the price level that does not include enery and food. This is done becasue energy and food prices have historically been more volatile and "skew" the rate of inflation for most goods and servies. When reporting the rate of inflation during the period when energy prices were rising rapidly, using the "core" rate under reported the more broad level of prices. Today, reporting the "core" rate may be greatly overstating the level of inflation.

    Recently, as energy prices have risen and fallen so rapidly and to extremes, does it make sense to exclude energy? The BLS added this comment, "Food prices increased 0.2 percent in November following a 0.3 percent rise in October. Excluding food and energy, the CPI was virtually unchanged in November and is up 2.0 percent since November 2007."

    The BLS web page explains how they report the CPI. "Our broadest and most comprehensive CPI is called the All Items Consumer Price Index for All Urban Consumers (CPI-U) for the U.S. City Average, 1982-84 = 100.

    In addition to the All Items CPI, BLS publishes thousands of other consumer price indexes. One such index is called "All items less food and energy". Some users of CPI data use this index because food and energy prices are relatively volatile, and these users want to focus on what they perceive to be the "core" or "underlying" rate of inflation."
     
  •  FOOD - "The food and beverages index rose 0.2 percent in November after increasing 0.3 percent in October. The food at home index was unchanged in November. The index for meat, poultry, fish and eggs turned down in November for the first time since February, falling 0.7 percent as the indexes for beef, fish, and eggs all declined. The fruits and vegetables index also declined for the third month in a row, with the decrease being driven by a decline in the fresh fruits index. These declines were offset by increases in the other grocery store food groups, including a 0.6 percent advance in the other food at home index and a 0.4 percent increase in the index for dairy and related products."
  • HOUSING - "The housing index fell 0.1 percent in November after being virtually unchanged in October. The index for shelter, virtually unchanged in October, rose 0.2 percent in November. Within shelter, the indexes for rent and owners' equivalent rent both rose 0.3 percent, while the index for lodging away from home fell 1.1 percent in November, its second straight significant decline."
     
  • TRANSPORTATION - "The transportation index declined 9.8 percent in November after falling 5.4 percent in October as several major components of the index continued to decline. The index for motor fuel fell 29.0 percent in November after decreasing 13.9 percent in October and is 28.6 percent lower than in November 2007. New and used motor vehicles, down 0.7 percent in October, fell 0.9 percent in November. The index for used cars and trucks declined 2.2 percent in November and the new vehicles index fell 0.6 percent and has declined 2.9 percent since November 2007. The index for public transportation, down 3.3 percent in October, fell 2.7 percent in November, with the airline fare index declining 4.0 percent. It was the third consecutive decrease in the airline fare index, but it is still up 4.0 percent since November 2007."
     
  • APPAREL - "The apparel index turned up in November, rising 0.3 percent after declining 1.0 percent in October. (Before seasonal adjustment, apparel prices declined 0.8 percent in November and are virtually unchanged from their November 2007 level."
     
  • MEDICAL CARE - "The index for medical care rose 0.2 percent in November, the same increase as in October, and was 2.7 percent higher than in November 2007. The medical care commodities index rose 0.6 percent in November following a 0.2 percent increase in October as the index for prescription drugs rose 0.6 percent in November after increasing 0.3 percent in each of the two prior months."
     
  • RECREATION - "After rising 0.1 percent in October, the index for recreation was virtually unchanged in November. The indexes for video and audio and for toys decreased in November while the indexes for pets, pet products and services, for sporting goods, and for admissions all posted increases."
     
  • EDUCATION AND COMMUNICATION - "The index for education and communication rose 0.2 percent in November, the same increase as the previous month. The index for education repeated its October increase of 0.4 percent while the communication index rose 0.1 percent after being virtually unchanged in October."
  • OTHER GOODS AND SERVICES - "The other goods and services index was virtually unchanged in November after rising 0.3 percent in October."

Clearly, the change in the price level (CPI) is not one single trend. Some spenging categories have increased and others have decreased. How does this affect you? That depends on how you spend your money.

For more details about the November 2008 price index changes for the various spending categories, see the BLS December 16, 2008 Release of CPI Data .

ASSESSMENT ACTIVITY

Essay Questions

  1. Explain how the percentage change in the CPI-U can be determined. [CPI (current month) (example) 202.416; Less previous index (last month) 201.800; Equals index point change .616; Index point difference (.616) divided by the previous index (201.800) equals 0.003; Results multiplied by one hundred 0.003x100 equals percent change (0.3).]
     
  2. What has been the general relationship between the changes in the CPI, real GDP growth and unemployment over the past couple of months? [There are three trends: 1) The CPI-U has declined over the past four months. 2) Real GDP began to decline in the third quarter of 2008. 3) The unemployment rate has increased significantly in recent months. These three trends are consistent with a severe recessionary period.]

CONCLUSION

The December 16 BLS report on the CPI adds further evidence to support concerns about the health of the U.S. economy. GDP has decreased. The rate of unemployment has increased. If the levels of production and employment are down, people's incomes will decrease. Falling prices may be a reflection of decreased consumer demand and decreased demand for productive resources.

Deflation, while resulting in lower product prices for consumers can have very negative impacts for the economy - decreased employment, reduced output, less investment and uncertainty about the future.

The CPI-U decreased by 1.9 percent (-1.7 percent seasonally adjusted) in November after decreasing by 1.0 percent in October. For the 12 month period ending in November 2008 the CPI was up 1.1 percent. The CPI decreases in October and November offset almost all of the price level increases of the previous ten months.

 

Percent changes in CPI for All Urban Consumers
2008 (CPI-U)

Month

CPI-U

Percent Change From

Previous Month

January 211.080 ---
February 211.693 0.3
March 213.528 0.9
April 214.823 0.6
May 216.632 0.8
June 218.815 1.1
July 219.964 0.8
August 219.086 -0.1
September 218.783 0.0
October 216.573 -1.0
November 212.425 -1.7

The period of deflation may have begun in August 2008. At the same time, the "liquidity crisis" began and the level of U.S. economic activity began to slow. The next Bureau of Economic Analysis (BEA) report on fourth quarter real GDP growth (released December 23, 2008)will most likely confirm the downward trend.

Take a look at the October, November and December announcements on real GDP growth and employment/unemployment to further explore and understand the downward trend in the past few months.

Links to past economic data announcements:

[Note to teachers: Students can access the CPI, GDP and Employment reports for recent years to review the economic data and determine the factors that were influencing the health of the U.S. economy in those years.]

EXTENSION ACTIVITY

BLS publishes reports on the CPI for three major metropolitan areas monthly: Chicago-Gary-Kenosha (IL-IN-WI), Los Angeles-Riverside-Orange County (CA), and New York-Northern NJ-Long Island (NY-NJ-CT-PA). It also publishes bi-monthly reports for 11 major metropolitan areas and semi-annual reports for an additional 13 smaller metropolitan areas.

You can use the Consumer Price Index News Releases Issued by BLS Regional Information Offices to compare your region to others. You will not be able to access the November 2008 data for metropolitan areas until a later date.