Inflation is one of the most important ways the economy impacts consumers. During periods of high inflation, money simply doesn’t go as far, so people need to watch their budgets more carefully.
One important measure of inflation – and how it impacts you – is the consumer price index, a monthly statistic the U.S. Bureau of Labor Statistics calculates that shows the change in the cost of goods and services.
“It’s a barometer for whether the things that consumers buy every day are getting more or less expensive,” Michael Arone, chief investment strategist and managing director at State Street Global Advisors, says.
In November, the CPI increased 7.1% from the previous year and 0.1% from the previous month, according to the BLS. While a 7.1% annual inflation rate is higher than most economists would prefer, it’s lower than the October rate – and a sign that high inflation may be beginning to cool.
Still not sure what CPI means? Read on:
What Is the Consumer Price Index?
The CPI is a measure of how the cost of a given “basket of goods and services” changes from month to month or year to year. The BLS calculates the CPI by surveying consumers to determine how much they pay for things such as energy, food, housing and travel. A high CPI means that you must spend more to purchase the same goods – and that cash savings are losing value over time.
“If you look at the CPI number and it’s up 8% over the course of the last year but your salary isn’t up 8%, then you’re losing ground financially,” Scott Wren, senior global equity strategist and managing director at Wells Fargo Investment Advisors, says.
The BLS uses a straightforward price index formula to calculate the CPI. It takes the current price of a hypothetical basket of goods and services and subtracts that from the base price (from the previous month or year) of the same basket. Then, it divides that number by the base price and multiplies it by 100.
CPI Limitations
While the CPI is a useful metric, it has some limitations. For example, it typically surveys urban consumers, and the prices for some goods and services may differ in suburban or rural areas, making it less accurate for some.
In addition, the CPI measures one basket of goods – but each family may allocate their spending differently. For instance, if one household spends the bulk of their money eating out and another spends most of their budget on medical expenses, inflation will impact each of those families differently.
“While CPI is a great way to think about the economy in aggregate, the basket of goods that’s being measured is representative of an individual that may not actually exist in real life,” Jeffrey Roach, chief economist for LPL Financial, says.
“For example, I am not a renter, so I have a very different experience in this economy than someone who rents their home versus owning it,” he says.
Which Is Better, a High or Low CPI?
In general, a low CPI is better than a very high one but a healthy and growing economy does experience some inflation. The Federal Reserve has said it targets 2% inflation (though it uses the personal consumption expenditures price index, a similar but slightly different measure of inflation) when deciding to make changes to the target-funds rate to slow down or boost the economy.
“If inflation is higher than the Fed deems appropriate, it will raise interest rates and tighten financial conditions, which can translate to higher mortgage costs, bond yields and credit card interest rates,” John Velis, FX and global macro strategist at BNY Mellon Markets in New York, says.
“That has the effect of slowing the economy and reducing rising prices,” he says.
Source link
