hr: Money

What is inflation? We hear people talk about it, but what does it really mean? Talk about inflation, and how it affects the stock market and prices of goods, are actually based on the Consumer Price Index.

“The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services,” according to the Bureau of Labor Statistics.

The CPI affects nearly all Americans because of the many ways it is used:

• As an economic indicator.
• As a deflator of other economic series.
• As a means of adjusting dollar values.

The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.

Why does CPI matter?

• Payouts on inflation-protected investments like TIPS and Series I bonds are indexed directly to the CPI.
• Social security payments, pensions, and inflation-indexed annuities all rely on CPI data to determine their annual adjustments.
• The size of individual income tax brackets, personal exemptions, and the standard deduction are tied to movements in the CPI.
• Low inflation numbers (especially when they are much less than GDP growth) make the economy seem healthy.

The budgetary effect of any overestimate of changes in the cost of living highlights the possibility of a shift in the distribution of wealth. If the CPI has an upward bias, some federal programs would overcompensate for the effect of price changes on living standards, and wealth would be transferred from younger and future generations to current recipients of indexed federal programs-an effect that legislators may not have intended.

The U.S. Bureau of Labor Statistics measures two kinds of CPI statistics: CPI for urban wage earners and clerical workers (CPI-W), and the chained CPI for all urban consumers (C-CPI-U). Of the two types of CPI, the C-CPI-U is a better representation of the general public, because it accounts for about 87% of the population.

CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. This is because large rises in CPI during a short period of time typically denote periods of inflation and large drops in CPI during a short period of time usually mark periods of deflation.

Variations of the CPI are published monthly by the Bureau of Labor Statistics, where they track the prices consumer pay for goods and services. If the government detects an increase in the price consumer pay for these goods, it’s called inflation.