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Economic Reports: Inflation

As you may have heard over the last couple of weeks, I am doing a series on the various economic indicators that are released by government agencies, NGOs, and other private groups. Some of these you may be familiar with, but I realized that not everyone may know what these indicators mean, where they come from, and why they are important. If there is an indicator that you have heard about that you would like to know more about, please feel free to call the show at 904.22.8255, or email me at info@vanwiefinancial.com and I’ll move that one to the top of the list.

This week, I am going to discuss inflation. In some ways, inflation has a bad reputation, when in reality there are many things about inflation that are positive. Inflation is defined by Investopedia as “the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.” Of course when the cost of goods is rising, especially when it is rising faster than wages, everyone hates inflation. However, when paychecks go up, which is inflation in the cost of labor, everyone is happy! Inflation is always a double edged sword, which I will explain in more detail in a bit.

The main measure of inflation is the CPI, or the Consumer Price Index, brought to you by none other than the folks at the Bureau of Labor Statistics. According to the BLS, the CPI is “a measure of the average change over time in the prices paid by urban consumers for a market basket of goods and services.” The goal of the CPI  is to measure inflation as felt by the consumer. There are other indexes produced by the BLS that measure inflation in a different way, in cluding the Producer Price Index (PPI), and the Employment Cost Index (ECI).

One group the CPI looks at covers about 89% of Americans, and is called the all urban consumer group (CPI-U). It is based on the expenditures of all people living in metropolitan areas in the United States, and does not consider income, wealth, employment status, or any other factor. Not included in this group are people who live in rural areas, people in the Armed Forces, and people who are incarcerated. 

The second group covers about 28% of the United States population, and is called the Consumer Price Index for Wage Earners and Clerical Workers (or CPI-W), and is really a subset of the CPI-U. It includes all the people in the CPI-U that have at least half of their household income from clerical or wage work, and have been employed for at least 37 weeks during the last 32 months. 

In order to determine the CPI, the BLS must determine what constitutes a basket of goods. The basket of goods is made up of eight catagories, including food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. Sales tax is included in the calculation, but income tax and social security tax are excluded because they do not correspond directly to the price paid for a good or service. The BLS determines what this basket looks like by surveying individuals and families about their actual purchases. The last surveys were done in 2013 and 2014, and more than 7,000 kept detailed records and reported what they purchased in a 2 week period. 

In order to present a CPI number each month, the BLS calls around to thousands of businesses across the United States to get information on current pricing of various products and services. Information is collected on about 80,000 items each month, and from that the CPI is derived. 

There are alternative measures of inflation, some of which are pretty fun to look at. My favorite alternative it the Big Mac Index, which is published by The Economist. Surprisingly, the Big Mac index is just what it sounds like, and is incredibly accurate. The Big Mac index can measure the difference in the cost of an equal good (the Big Mac) in different parts of a country, or it can be used to measure purchasing power parity in different parts of the world. 

Another alternative to the CPI is the Chapwood Index. This inflation measure looks at the actual cost of living in America’s 50 largest cities by measuring the actual cost of the top 500 items on which Americans spend money. It is updated every 6 months, and shows a very different picture than the CPI. For instance, in 2014, the CPI showed an increase of 0.8% increase in the cost of living accross the US. For the same year in Boston, the Chapwood index showed an increase of more than 10%! While this data is not as widely used, it is believed by many to be a better estimate of actual inflation.