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Inflation Basics

Inflation Basics. Dr. D. Foster – ECO 285 – Spring 2014. Required Readings - CPI. Critiquing the CPI (St. Louis Fed) Overview of BLS Statistics on Inflation and Prices (BLS) Common misconceptions about the CPI – Q&A (BLS) Response to BLS (Shadow Gov’t Statistics)

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Inflation Basics

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  1. Inflation Basics Dr. D. Foster – ECO 285 – Spring 2014

  2. Required Readings - CPI • Critiquing the CPI (St. Louis Fed) • Overview of BLS Statistics on Inflation and Prices (BLS) • Common misconceptions about the CPI – Q&A (BLS) • Response to BLS (Shadow Gov’t Statistics) • Alternative Inflation Measures (Shadow Gov’t Statistics) • Differences between CPI-U and C-CPI-U (CBO) • Chained, Chained, Chained (The Economist) • Taking the Price Temperature (Mises.org) • Peter Schiff on “inflation propaganda” (YouTube)

  3. Inflation Defined A continuous rise in the general price level. • Not a rise in some prices. • Not a one-time rise in prices. • What is the “general price level”? • Price level is shown by a Price Index • Hold quantities constant over time • Use old quantities • Use new quantities • Allow some quantity change Laspeyres; CPI Paasche Chained CPI & GDP deflator

  4. Laspeyres & Paasche price indexes ∑(P1*Q0) ∑(P0*Q0) $456.00 $441.25 • Laspeyres: • Paasche: = = 103.34 ∑(P1*Q1) ∑(P0*Q1) $447.00 $440.50 = 101.48 = The CPI uses a Laspeyres index like this, showing inflation of 3.34%.

  5. The Consumer Price Index(es) • CPI-U: All urban consumers • A fixed-weight index: consumption patterns rigid. • Market basket is updated every two years. • Represents about 87% of U.S. population. • Used to adjust income tax brackets to account for inflation. • Monthly, 60,000 prices are collected. • Goods & services comprise 200 groups. • Eight broad categories:

  6. The Consumer Price Index(es) • CPI-U: All urban consumers • A fixed-weight index: consumption patterns rigid. • Market basket is updated every two years. • Represents about 87% of U.S. population. • Used to adjust income tax brackets to account for inflation. • Monthly, 60,000 prices are collected. • Goods & services comprise 200 groups. • Eight broad categories: • FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks) • HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture) • APPAREL (men's shirts and sweaters, women's dresses, jewelry) • TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance) • MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services) • RECREATION (televisions, toys, 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 services, funeral expenses).

  7. CPI-U from 1947, 1970 and 2000

  8. The Consumer Price Index(es) • CPI-W: Urban wage earners & clerical workers • A fixed-weight index. • Represents about 32% of U.S. population. • Half of HH income from clerical, craft, service. • Excludes salaried, part-time, self-employed … • Records average spending on 80,000 items in 87 geographical areas around the country. • Used to adjust Social Security payments to keep up with cost of living (COLAs).

  9. The Consumer Price Index(es) • C-CPI-U: Chained CPI, all consumers • A variable-weight index. • Designed to account for “substitution bias.” • When the price of pork rises, people buy more fish. • CPI-U only accounts for narrow substitution, e.g., if the price of Granny Smith apples rise relative to Red Delicious. • Designed to be a better measure of the cost of living. • Records consumer expenditures each month and allows for changing composition of the basket.

  10. Chained CPI-U from 2000

  11. Comparing CPI-U with C-CPI-U

  12. Using Price Indexes • Converts nominal values into real values: • Example: Your income in 2013 is $32,000 and in 2014 it is $33,100.Q - Are you “better off?” • Convert to “real income” by looking at CPI: Say it was 172.2 in 2013 and 179.9 in 2014

  13. Features of Price Indexes CPI2003 = 184 CPI2013 = 233 Inflation = (233-184)/184 = 26.6% Approx. annual inflation = 2.66% (10 years) Actual ave. annual inflation = (233/184)^(1/10)-1 = 2.39%

  14. Calculating the C-CPI-U L: 103.34 P: 101.48

  15. For further information (recommended) • Wiki on Price Index • Wiki on Consumer Price Index • Wiki on Chained Consumer Price Index • The Chained CPI: What Is It … • Wiki on Producer Price Index • BLS on Producer Price Index FAQs • Wiki on GDP Deflator

  16. Inflation Basics Dr. D. Foster – ECO 285 – Spring 2014

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