Posted: 7/13/2008 9:32:15 AM EDT
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I decided to go through the effort of typing this to help people learn exactly HOW the government calculates the two main inflation indicators, and the reasoning behind their methods. I see a lot of people gnashing their teeth claiming the government is trying to hide something from them. The bottom line is that the causes of inflation are still the subject of debate, and that the method for trying to measure it is always going to be a less than perfect science. The two indicators we will be discussing are the CPI (Consumer Price Index) and the PPI (Producer Price Index). The CPI is a measurement of pricing at the consumer level. The PPI is a measurement of prices at three stages of manufacture: Crude, Intermediate, and Finished. These indicators are used by policymakers to set future economic and fiscal policy. In our economy, inflation is a curse and a blessing. It is a delicate balancing of the two that is desired by the fed, congress and everyone else. Price stability is what policymakers hope to achieve. We will now look at each indicator in depth. First, the CPI. This is the figure you hear everyone talking about on the news. Their are many figures generated by this report. Different people care about various ones for varying reasons. They all are derived from the same data. Each month, prices are collected on thousands of goods. Tens of thousands. Services are also included. Adjustments are made to account for packaging and technological changes. (If a 10 oz. bag of widgets cost $10 last month, and now it is a 12 oz. bag still costing $10, it is viewed as a 20% drop) Needless to say, this alone is a daunting task. The data is then divided into 8 major categories. 1. Housing 2. Food and Beverages 3. Transportation 4. Medical Care 5. Clothes 6. Recreation 7. Education/comm. 8. Other These categories are weighted according to the results of surveys of average national and local rates of consumption. This is also an inexact science. Every person allocates their resources differently. AFter this is done, the figures are tallied into the main CPI reading, the core-CPI which excludes food and energy. Figures are also created and used to calculate cost of living increases for unions and government dependants (SS etc.) The Core-CPI is the figure most widely known because it is the number that the fed likes to use to set interest rate policy (though by no means the only factor). It excludes food and energy because these two groups are subject to price fluctuations that have nothing to do with real inflationary pressures. Spikes in food and energy due to natural or man-made supply shocks can cloud the overall inflation figure and make it more difficult to see the underlying inflationary trend. Setting fiscal policy without removing these items can murder the economy. These figures are NOT removed to pull the wool over anyones eyes or play us all as fools. Even a universal D-bag can look at the price advertised at the pump and know it sucks. These figures are not here to reassure or frighten the average person. They are simply here to allow policymakers to make as informed a decision as possible. This figure does have an effect and is closely watched by many people for good reason. They want to see what the fed may do. Interest rate policy has become the single foremost weapon the fed uses to speed or slow the economy. An investor in bonds will be very interested in future interest rate policy by the fed as it will affect whether bond prices go up or down. A company is interested in this figure as it will use it to formulate forecasts for their industry. When this figure gets too high, the fed will look to raise interest rates, thus slashing access to capital and slowing the economy. Higher rates mean tougher access to capital for businesses AND consumers. It affects the consumer by raising adjustable rates on debt like credit cards and home equity. This decreases consumer spending and brings the economy back into a price stable equilibrium. (theoretically: real life is a bitch) The PPI is basically the same thing except it measures prices at the pre-consumer level. These figures usually show inflationary pressure first. The PPI has three main indexes: Crude goods, Intermediate goods, and Finished goods. Crude goods are essentially processed raw materials. Intrermediate goods are like car parts shipped from a supplier, and finished goods are products ready to be delivered to the wholesaler. Finished goods are the headline grabber. Increases here will soon be reflected in the CPI. In practice inflation generally "rolls" through these stages and into the CPI. The bottom line is the only reason we need to be looking at these figures is if we are active investors, policymakers, media fear-mongers, or are trying to plan major purchases. Their is nothing we can do to change the inflation figure, and believe me, the government does not like it when it goes up. I just wish people would really try and lose the consiracy theories and emotion and just look at it for what it is: a tool in the feds toolbox to help achieve their purpose; price stability with low unemployment. This makes it useful for forward looking investors, companies, and individuals. Hope this helps, sorry I am the suck at writing.  Have fun sorting through this: www.bls.gov/cpi Very informative with all the boring statistics one can stand to sort through. The enormity of the CPI release should help to show how difficult it is to ACCURATELY portray the inflationary picture, and demonstrate the need for removing the excessively volatile energy and food groups from the Core-CPI. |
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Here is the table broken down. Note the HIGH changes from May 2007 until now in the food and energy sections. www.bls.gov/news.release/cpi.t01.htm |