INFLATION
(William McDonough, President, FED Board of New York) "Inflation is a serious impediment to efficient resource allocation and economic development. It reduces the effectiveness of the price mechanism and the contribution or market forces to economic growth through a variety of channels: by obscuring the signaling role or relative price changes, the major guide for making efficient resource allocations; by increasing uncertainty about the outcome of business decisions and profitability; by causing adverse effects on the cost of capital through its interactions with the tax system; by hampering the application of new technologies and ideas; and by diverging resources away from productive activities. It is clear to me than low inflation, or price stability, is essential for achieving maximum long run economic growth".
HISTORY OF COST OF LIVING ADJUSTMENTS
Year Cola Year Cola Year Cola Year Cola
1975 8.0% 1981 11.2 1987 4.2 1993 2.6
1976 6.4 1982 7.4 1988 4.0 1994 2.8
1977 5.9 1983 3.5 1989 4.7 1995 2.6
1978 6.5 1984 3.5 1990 5.4 1996 2.9
1979 9.9 1985 3.1 1991 3.7 1997 2.3
1980 14.3 1986 1.3 1992 3.0
1998- 1.6
1999- 2.2
2000- 3.4
INFLATION IS GOING DOWN WITHOUT GOING DOWN: (1998) Say what? Noted previously, Greenspan has said for a long time that the CPI was not truly reflecting the buying practices of the consumers. So the CPI is now being adjusted for the 6th time since 1921 and should slow the CPI's annual growth by 0.1% to 0.2%. Each 1% CPI increase will cost the government about $6 billion by 1999. That's due to the fact that there are CPI adjustments for 47.8 million Social Security recipients, 4.1 military and civil service retirees, 2.4 million food stamp recipients and 26.7 million children who receive school lunches.
Here are the spending weights for the CPI
Old New
Food and Beverages 17.5% 16.3%
Housing 41.5 39.6
Apparel 15.3 4.9
Transportation 16.6 17.6
Medical Care 7.4 5.6
Recreation (formerly entertainment) 4.3 6.2
Education and Communications N/A 5.5
Other Goods and Services 7.4 4.3
Measures of Inflation (1999)
Consumer Price Index (CPI)
CPI is a measure of the average level of prices of a fixed "market basket" of goods and services purchased by consumers (food, clothing, utilities etc.). CPI is an indicator of inflation on
the retail level.This is calculated every month by the Bureau of Labor Statistics
The are 2 major CPI's:
CPI-U (U is for Urban) which represents about 80% of the total U.S. population. It is based on the expenditures reported by almost all urban residents, including professional employees, the self-employed, the poor, the unemployed, and retired persons as well as urban wage earners and clerical workers.
CPI-W is based on the expenditures of urban households that meet additional 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. CPI-W represents about 37% of the population.
The CPI-U is usually the "CPI" most people refer to.
CPI includes:
Food and beverages (cookies, cereals, cheese, coffee, chicken, beer and ale, restaurant meals)
Housing (residential rent, homeowners' costs, fuel oil, soaps and detergents)
Apparel and its upkeep (men's shirts, women's dresses, jewelry)
Transportation (airline fares, new and used cars, gasoline, car insurance)
Medical care (prescription drugs, eye care, physicians' services, hospital rooms)
Recreation (newspapers, toys, musical instruments, admissions);
Education and communication (tuition, postage, telephone services, computers);and
Other goods and services (haircuts, cosmetics, bank fees)
CPI is seasonally adjusted to cull apart the changes that are seasonal from the underlying economic changes. Seasonal changes are fluctuations in prices that occur at the same time very year. They might be due to: automobile model changeovers, weather and holidays. For example, gasoline costs more in the summer, tomatoes cost more in the winter.
The unadjusted data is what people actually pay. The adjusted data is what is reported in the media. CPI is a number that reflects prices with 1982-1984 averages as 100.0. The adjusted index was 162.5 for April 1998 as compared to 162.2 for March so we say "CPI is +0.3%"
CPI is based on a very large sample of goods in a very large sample of places. The one criticism that can be made is that it takes no account for what people actually buy. If, because of El Nino, tomatoes which cost $1.39 a pound in March now cost $4.59 a pound, people will diminish their purchases. Because of this, CPI is, in terms of what people actually buy, slightly overstated.
PPI
PPI is the Producer Price Index - this measures the average change over time in the selling prices received by domestic producers of goods and services. PPI's measure price change from the perspective of the seller. This varies from CPI which is a measure of price change from the buyer's perspective. Sellers' and buyers' prices may differ due to subsidies, taxes, and the dynamics of distribution costs.
Implicit Price Deflator
While CPI might be the "Dow" of Inflation it is, in essence, a measure of the price that people pay for things and services. The economy, however consists of a bit more than individuals.
A broad measure of economic activity is GDP (Gross Domestic Product). The GDP Implicit Price Deflator or IPD is based on the Gross Domestic Product and therefore reflects price changes in all goods and services transactions in the United States, including the consumer, producer, investment, government and international sectors. The IPD for GDP takes into account the price changes of the goods and services that actually happened. The IPD for the GDP is, thus, a more meaningful measure of inflation than either CPI or PPI.
IPD might, for example, be used to adjust the cost of a long term projects such as Civil Engineering projects. The EPA, for example, writes it into the bids for toxic cleanup projects. If one wanted to compare the economic impact of natural disasters from different periods, it would be appropriate to normalize the dollar losses at the time that the occurred using IPD's.
ECI
ECI is the Employment Cost Index. Since we have been hearing about a tight labor market this might be where inflation showed first. ECI is the cost of labor on a fixed basket of occupations. This eliminates the effect of the influence of employment shifts among occupations. While the average hourly earnings data would be affected by a shift in the occupational composition of the workforce and would appear as a wage gains, ECI would not be affected.
Wages & salaries account for about 72% of the ECI. The rest is benefit costs.
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