According to the Wikipedia, “A Consumer Price Index (CPI) is a statistical measure of a weighted average of prices of a specified set of goods and services purchased by wage earners in urban areas. It is a price index which tracks the prices of a specified set of goods and the services, providing a measure of inflation.” It is a fixed quantity and a sort of cost –of- living index.
The CPI is used to track changes in prices of goods and services purchased for consumption by urban households.
Every month the Bureau of Labor Statistics (BLS) surveys prices and generates current CPI.
The increase in CPI is called inflation. This inflation can be calculated by finding the difference in the cost of an item one year compared to the same item’s cost in a later year.
The formula for calculating inflation rate is the following:
((B-A/A)*100
If prices go down, meaning we experience deflation, then “A” would be larger then “B” and then it would be negative.
The CPI indicates effectiveness of government policy and “for inflation targeting monetary policy makers is the usage of the CPI as a measurement for the inflation a key tool in their price policies.”(1) Also, business executives, labor leaders and other private citizens use the index as a guide in making economic decisions.
The index affects the income of almost 80 million people in the US as a result of statutory action. [See note #1]. The CPI also affects cost of lunches for school children. Also, private firms and individuals use it to keep rents , royalties, alimony, payments, and child support payments in line with changing prices. CPI is used to adjust Federal income tax as well.
Some people believe that elected officials don’t want the CPI to be “An honest measure of cost maintaining the same standard of living or quality of life.”(2) Instead, they want a politically convenient index which would hardly ever rise.
The CPI is manipulated so that there is no inflation, even though prices for things we must buy to live keep rising higher and higher. In this way, people will believe that inflation is low and the “fraud” of monetary inflation will stay alive. By changing “what inflation is”, then our government won’t have to pay as much to retirees, because retiree benefits like Social Security, Medicare, and Medicaid are tied to the CPI. Inflation is understated by about 2.7% per year.
So, instead of the CPI being used to help businesses and individuals for financial planning, it is being misused by politicians intent upon stealing income from Social Security recipients.
People on Wall Street also mess with the CPI. [See note #2].
After press reports surfaced in the 1990s about the CPI significantly overststing inflation, there were arguments that if the CPI inflation couls be reduced, then entitlements would not increase as much each year, and would ultimately help bring the budget deficit under control. The people behind this thinking, were Michael Boskin, the then chief economist to the first Bush administration, and Alan Greenspan, chairman of the Board of governors of the Federal Reserve System.
Before Boskin and Greenspan, the CPI was measured in a pretty straightforward concept. [See note #3]. Afterward, the weighing of goods was shifted to basic arithmetic weighing to geometric weighing. [See note #4].
The CPI is being totally messed with and is barely something we can depend upon.
According to an article by Richard Benson, “The primary sources of manipulation are: (1) making sure the wrong items are in the index ; (2) Taking “hedonics” to ridiculous extremes; (3) Getting customers to do more of the work and receive less services; and, (4) changing to a Chain Weighted Index.”[See note #5]
Now there are three CPI measures: CPI for all urban consumers, CPI for urban wage earners, and clerical workers, and the chained CPI-U. [See note #6].
There is also a problem with GDP (Gross Domestic Product ) reporting because of the way inflation is handled . CPI is not used in GDP calculation, but price deflators, used in converting GDP data, and growth to inflation adjusted numbers, are related. The more inflation keeps being understated , the inflation-adjusted rate of GDP growth that is reported will get higher.
Notes:
#1: 47.8 million Social Security beneficiaries, about 4.1 million military and Federal Civil Service retirees and survivors, and about 22.4 million food stamp recipients. Changes in the CPI also affect the cost of lunches for the 26.7 million children who eat lunch at school. Some private firms and individuals use the CPI to keep rents, royalties, alimony payments and child support payments in line with changing prices. Since 1985, the CPI has been used to adjust the Federal income tax structure to prevent inflation-induced increases in taxes.
#2 “The Pollyannas on Wall Street like to play games wit the CPI too. The concept of looking at the “core” rate of inflation-net of food and energy-was developed as a way of removing short-term (as in a month or two) volatility from inflation when energy and/or food prices turn volatile.”
#3 Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living.
#4 Shortly after Clinton took control of the White House, however, attitudes changed. The BLS initially did not institute a new CPI measurement using a variable-basket of goods that allowed substitution of hamburger for steak, but rather tried to approximate the effect by changing the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price.
#5 If the currencies are chained, the weights are changed every year. This takes into account that consumption patterns change over time. In the above example, assume that consumers now buy 10% foodstuffs but 30% of everything else (e.g. electronic gadgets), then a cheapening of these gadgets would show up less if the "base year" method is used rather than the "chained" method, since it would be weighted with only 20% instead of 30%. This would show higher price increases, overestimating inflation.
#6 The CPI-U includes expenditures by urban wage earners and clerical workers, professional, managerial, and technical workers, the self-employed, short-term workers, the unemployed, retirees and others not in the labor force. The CPI-W includes only expenditures by those in hourly wage earning or clerical jobs. Recently, the Chained Consumer Price Index C-CPI-U, a chained index, was introduced. The C-CPI-U tries to militate against the substitution bias that is encountered in CPI-W and CPI-U employing a Tornqvist formula and utilize expenditure data in adjacent time periods in order to reflect the effect of any substitution that consumers make across item categories in response to changes in relative prices. The new measure, said to be a "superlative" index, is designed to be a closer approximation to a "cost-of- living" index than the present measures. The use of expenditure data for both a base period and the current period in order to average price change across item categories distinguishes the C-CPI-U from the existing CPI measures, which use only a single expenditure base period to compute the price change over time. In 1999, the BLS introduced a geometric mean estimator for averaging prices within most of the index’s item categories in order to approximate the effect of consumers’ responses to changes in relative prices within these item categories. The geometric mean estimator is used in the C-CPI-U in the same item categories in which it is now used in the CPI-U and CPI-W.
Resources:
(1)www.safehaven.com
(2)www.gillespiereserch.com
(3)www.wikipedia.org
(4) www.inflationdata.com