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 17, 2010, BLS press release of data on the consumer price index for the month of August, 2010.
- 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.
On January 14, 2011, the U.S. Bureau of Labor Statistics (BLS) reported that the seasonally adjusted U.S. consumer prices index for all urban consumers (CPI-U) increased by 0.5 percent in December, 2010, the largest monthly increase in consumer prices since July, 2008. The BLS added that a jump in gasoline prices (up 8.5 percent for the month) accounted for 80 percent of the total seasonally adjusted increase in December.
What does this possible new evidence of inflation mean to you, your family, and the economy?
To better understand this data, it is important to start with a few key price level definitions:
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.
What is Inflation?
Inflation is generally defined 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. 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.
Is this definition what you thought inflation was?
The January 14, 2010, Bureau of Labor Statistics Announcement
Consumer Price Index and Inflation - December - 2010
Released January 14, 2011
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in December on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.5 percent before seasonal adjustment."
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.”
In the announcement, the BLS quickly identified energy prices, specifically gasoline, as the primary driver of the overall price increase.
"The energy index increased in December. The gasoline index rose sharply and accounted for about 80 percent of the all items seasonally adjusted increase. The household energy index, which declined in November, increased as well. The food index increased slightly in December, with the fruits and vegetables index rising notably."
Because energy and food prices tend to fluctuate more than most other consumer good and services prices, the BLS also reports an "index for all items less food and energy." This is commonly referred to as the "core index."
"The index for all items less food and energy also rose in December. An increase in the shelter index accounted for about 60 percent of the rise, and the indexes for airline fares, medical care and apparel rose as well. These increases more than offset declines in the indexes for communication, recreation, and household furnishings and operations."
What was the Level of the CPI-U in December 2010?
"The Consumer Price Index for All Urban Consumers (CPI-U) increased 1.5 percent over the last 12 months to an index level of 219.179 (1982-84=100). For the month, the index increased 0.2 percent prior to seasonal adjustment."
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 1.7 percent over the last 12 months to an index level of 215.262 (1982-84 = 100). For the month, the index rose 0.2 percent prior to seasonal adjustment."
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.
Substitute: A good or service that may be used in place of another good or service; examples include tap water for bottled water (or vice versa) and movies for concerts (or vice versa).
Typically, a consumer will substitute one good for another good based on their relative prices. If consumers substitute one good for another good that is part of the market basket, it is not reflected in the CPI-U. The C-CPI-U is adjusted for these changes.
"The Chained Consumer Price Index for All Urban Consumers (C-CPI-U) increased 1.4 percent over the last 12 months. For the month, the index increased 0.2 percent on a not seasonally adjusted basis."
CPI Example: The level of the CPI-U in December was 219.179. That means a market basket of goods that cost $100 in 1982-1984 (the base year) now costs $219.18. That same basket cost $215.95 in December of 2010, an increase of . If your monthly income has increased by about $3.23 in the past year, your income has kept-up with inflation (at least with the price of this market basket of goods and services.) Remember, this is a "sample" market basket. If your spending habits are significantly different from the "average" the impact of inflation on you is different. If you spent more than the average on energy in August, inflation affected you more.
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.
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)
Figure 1, below, shows the December 2010 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: Consumer Price Index for All Urban Consumers (CPI-U)
U.S. City Average by Expenditure Category
(Base year, 1982-84=100, unless otherwise noted (4))
Dec. 2010 (2)
Dec. 2009 to
Dec. 2010 (2)
|Food and beverages||14.795||221.278||1.5||0.1|
|Food at home||7.801||216.955||1.7||0.1|
|Food away from home (2)||5.937||227.722||1.3||0.1|
|Fuels and utlities||5.081||212.505||1.8||0.7|
|New and used motor vehicles (4)||6.386||97.046||0.6||0.0|
|Gasoline (all types)||4.337||255.319||13.8||8.5|
|Education and communication (4)||6.434||130.548||1.3||-0.1|
|Other goods and services||3.483||384.502||1.9||0.2|
|(1) Weight= Relative importance, established in December 2009|
|(2) Not-seasonally adjusted index|
|(3) Seasonally adjusted index|
|(4) The base year for these categories is 1997|
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.
Figure 2, below, shows the changes in the CPI-U price level from 2002 through December, 2010. 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.
Figure 3, below, shows how the change in the CPI was determined for December, 2010.
Figure 3: How the CPI is Calculated?
|Index Point Change|
|CPI - Current Period||219.179|
|Less previous index||215.949|
|Equals index point change||3.230|
|Index point difference||3.230|
|Divided by the previous index||215.949|
|Results multiplied by one hundred||0.001495 x 100|
|Equals percent change||1.495 (1.5% reported rate)|
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.
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.
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.
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.
The U.S. Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in December on a seasonally adjusted basis. This was the largest monthly increase in the consumer price index since July, 2008. For the past year, the CPI-U has increased 1.5 percent (not seasonally adjusted).
Is this a significant increase in the U.S. price level? Remember, much of the increase in December was due to increased fuel prices. The seasonally adjusted "core" cpi (all items less food and energy) increased just 0.1 percent in December.
Many media analysts and planners are projecting much higher energy prices, especially gasoline, in the coming year. If, in fact, gasoline reaches $4-5 per gallon in 2011, many consumers will have to make tough decisions about their budgets. But remember, gasoline makes up just 4.3 percent of the CPI "market basket." If a consumer drives much more than the average, the impact of high gasoline prices is greater.
Does the fact that gasoline prices are clearly advertised on big signs on the corners make them seem more important?
Keep an eye on energy prices as a part of the more broad CPI-U over the coming months to determine if the CPI-U or the all items less food and energy price level is the most meaningful for those who have to plan their spending.
Next, answer the following questions on the interactive notepad below.
1. What is the different between demand-pull and cost-push inflation?
2. Which measurement, the CPI-U or the core rate is the most meaningful measurement of inflation?
3. Explain how a borrower can actually benefit from inflation?
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.
Students: Read the summary of the "Misconceptions" and discuss whether or not the CPI-U is a meaningful measurement of cost of living.