Inflation measures the rise in the general level of prices, and I would like you all to think about the role that certain prices play in thinking about inflation. Gas prices are one of the most visible prices around, and people consistently confuse them with overall inflation. However, energy prices are certainly important to many people in everyday life, and if they remain elevated for extended periods general consumer prices are likely to rise as a result. On the other hand, some prices like clothing have fallen in recent months. What we don’t see in inflation numbers is a shift in behavior. As gas prices rise, or clothing prices fall, people are allowed to reallocate their expenditures in the basket of goods they consume, but the CPI does not perform that reallocation. It also appears that the U.S. is better able to handle an increase in fuel prices at this time than we might have been able to handle the increase several years ago.
Questions you might try to answer (Just worry about answering ONE of these questions or ONE of your own related to the topic):
- Explore specific categories of prices in the CPI for recent increases or decreases, and relate that to the importance it has in the everyday budget. Are there some goods that are very visible that might drive people’s perception of inflation higher even though overall inflation is not very high? See the BLS site (http://www.bls.gov/news.release/cpi.t02.htm) or the St. Louis Fed (http://research.stlouisfed.org/fred2/release?rid=10) for detailed information. I would like you to report numbers to support your claims. On the St. Louis Fed site, once you click on a category, you can change the view from levels (which is an index) to rates of change (inflation) by going to “Units: Levels” under the graph and selecting “Chg. from Yr. Ago” as the units. Now your graph is in annual rates of inflation rather than an “obscure” index value. See an example here and here for a before and after.
- As people shift their consumption patterns over time, the rates of inflation we measure are influenced because of the fact that there is no substitution in the basket used to estimate the CPI. The Consumer Expenditure Survey provides updated information on what people are spending their money on. If you look at housing, why are people spending less on housing now than they were a few years ago? How might this be incorporated into our measures of inflation? What about other things like cell-phone versus landline phone service? Do these changes make it difficult to measure inflation on aggregate, and might this lead to some of the misunderstanding regarding what is reported as inflation?
- The Fed uses a different measure when discussing inflation called the Personal Consumption Expenditures (PCE) index that differs from the CPI. Why might we prefer to use this index to the CPI? Find a reputable (non-Wikipedia) source to refute your claims? Do you think this also leads to some confusion about what constitutes inflation?