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CPI - What Are We Looking At Here?

Have you noticed that the $100 you just spent at the grocery store bought significantly less groceries than it did last year? Inflation is to blame for this, and it affects your purchasing power.

So, what is inflation, and how can it be measured? The Consumer Price Index (CPI) is a key economic metric that tracks the rate of change in U.S. inflation over time. It is based on prices that consumers pay for goods and services throughout the U.S. economy. The percentage change in CPI over a period of time is referred to as the inflation rate.

Monthly Report Calculations

The U.S. Bureau of Labor Statistics (BLS) releases a monthly CPI report that includes statistics about how the prices of different goods and services change over the last month and the last 12-month period.

The CPI calculation tracks the change in the prices of a fixed basket of goods and services, including popular items that Americans regularly purchase. The value of the basket is proportional to how they are sold.

In order to calculate CPI, the current cost of the basket is compared to its cost in the prior year and then multiplied by 100 to find a percentage. The calculated CPI is then used to determine the inflation rate.

CPI figures might seem pretty abstract, but they reflect the very real price changes that affect every aspect of your day-to-day spending. CPI impacts your finances by measuring your purchasing power, guiding economic policy, determining government benefits, and driving salary increases at work.

The monthly CPI report includes inflation rates for various goods and services, as well as the rate of inflation in various regions across the United States.

It starts with a summary of the findings, including how much inflation either increased or decreased for the month prior, followed by the average change in prices over the past 12 months. The report includes information about which categories drove the increase or decrease in prices.

Limitations of CPI data

However, the CPI has limitations in what it reports and who it represents. For example, it only measures inflation for U.S. urban populations, thus leaving out the inflation experience of people living in rural areas.

It also doesn’t include estimates of how different subgroups are experiencing inflation, such as the elderly or those living in poverty. By creating blanket assumptions of how people are affected by inflation, the CPI may not capture the full picture.

History of CPI

Over the last 50 years, the CPI has undergone a number of changes in methodology and composition, as well as shifts in its importance as an economic indicator.

In the early 1970s, the CPI was primarily used as a tool for adjusting government payments, such as Social Security benefits, to keep up with inflation. At that time, the CPI was based on a fixed basket of goods and services that represented the spending patterns of urban consumers.

The basket was updated periodically; but did not reflect changes in consumer preferences or the introduction of new products.

In the 1980s, the BLS began making a number of changes to the CPI to better reflect changes in consumer behavior and market conditions. These changes included updating the basket of goods and services more frequently, as well as adjusting the weights assigned to different items in the basket based on consumer spending patterns.

One major change to the CPI during this time period was the introduction of the "hedonic quality adjustment," which allowed the BLS to account for improvements in the quality of goods over time.

For example, if a new computer was introduced that was twice as fast as the previous model, but cost the same amount, the CPI would not show any inflation. However, using the hedonic quality adjustment, the BLS could adjust the price of the new computer to reflect the fact that it provided more value for the same price.

In the 1990s, the CPI underwent another major revision with the introduction of the "chained CPI." The chained CPI is a modified version of the traditional CPI that takes into account changes in consumer behavior as prices rise.

For example, if the price of beef goes up, consumers may switch to chicken, which is typically cheaper. The chained CPI adjusts for this change in behavior, whereas the traditional CPI does not.

The chained CPI is considered by many economists to be a more accurate measure of inflation, as it reflects changes in consumer behavior and spending patterns. However, it is not widely used for government payments, as it typically results in lower cost-of-living adjustments.

CPI in the 21st Century

After 2000, the CPI was starting to become less important as an economic indicator, as the Federal Reserve has shifted its focus to other measures of inflation, such as the Personal Consumption Expenditures (PCE) price index. The PCE is similar to the CPI, but includes a broader range of goods and services, and is weighted based on actual consumer spending patterns.

In 2020, the COVID-19 pandemic had a significant impact on the CPI. As many businesses closed and consumers stayed home, demand for certain goods and services declined, leading to lower prices.

Take for example when the price of gasoline dropped significantly as people stopped driving to work and traveling. At the same time, there were shortages of certain goods, such as toilet paper and cleaning supplies, which led to price increases for those items.

In 2021, as vaccination rates increased and businesses reopened, there were signs of inflationary pressures building in the economy. The CPI rose steadily throughout the year, reflecting higher prices for goods and services.

Some of the factors contributing to inflation included supply chain disruptions, increased demand for certain goods and services as the economy reopened, and higher prices for raw materials.

In 2022, as inflation began to make a roaring comeback after two years of artificial suppression by the fed, the CPI data releases became pivotal moments for investors, as volatility rose considerably and the market reaction to “hot” or “cold” numbers could dramatically move markets.

Consumer prices for all items rose 6.5 percent from December 2021 to December 2022. Food prices increased 10.4 percent, reflecting an 11.8-percent increase in prices for food at home and an 8.3-percent increase in prices for food away from home.

See the chart below for the overview of 2018-2022:

Going forward into 2023, we have seen a year-over-year increase of 6.4% and 6.0% in January and February respectively. What will March numbers reveal?

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