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Economic Trends
How Do We Measure Inflation?
By Roger Wohlner
CERTIFIED FINANCIAL PLANNER™ Practioner, Asset Strategy Consultants
The most commonly cited measure of inflation is the consumer price index (CPI). However, the government releases not one, but three, versions of the CPI:
CPI-U
The CPI for all urban consumers, the most commonly cited of the three indexes, is based on expenditures of almost all residents of urban or metropolitan areas, including urban wage earners and clerical workers, professionals, the self-employed, the poor, the unemployed, and retired individuals. It represents about 87% of the U.S. population and does not include individuals in rural nonmetropolitan areas, farm families, persons in the Armed Forces, and those in institutions such as prisons and mental hospitals (Source: Bureau of Labor Statistics, 2005).
CPI-W
The CPI for urban wage earners and clerical workers is based only on expenditures of wage earners and clerical workers in urban or metropolitan areas, representing approximately 32% of the U.S. population (Source: Bureau of Labor Statistics, 2005). This index is typically used to make cost-of-living adjustments for labor contracts and Social Security benefits.
C-CPI-U
The chained CPI for all urban consumers, released in July 2002, covers the same expenditures as the CPI-U, but is calculated in a different manner. Started during the 1990s, the CPI-U and CPI-W allow for modest consumer substitution of items within the same categories to compensate for price changes. The C-CPI-U, on the other hand, also allows for consumer substitution between categories. These calculation differences typically mean that the C-CPI-U will show a lower inflation rate than the CPI-U.
All three CPIs measure the average change in prices paid by consumers for over 200 categories of goods and services in eight major categories - food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. The CPIs are weighted averages, reflecting the importance of each category in the average consumer's overall expenditures. For the CPI-U and CPI-W, the weightings are based on consumer expenditure surveys and stay fixed for a two-year period. The C-CPI-U index, on the other hand, uses contemporaneous monthly expenditure estimates. The CPI-U and CPI-W are calculated for the entire nation, for broad geographic regions, and for large metropolitan areas, while only a national C-CPI-U is calculated.
In addition to these three indexes, references are often made to core inflation, typically when monetary policy decisions are discussed. Core inflation typically means the CPI-U index excluding food and energy prices, which represents approximately 23% of consumer spending in the CPI. Food and energy prices are excluded because their prices tend to be more volatile and often change significantly over short time periods due to outside factors.
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