Yesterday, the Consumer Price Index for December 2009 was released. The good news is that inflation over the past year has not been a problem in the U.S.
Year-over-Year Prices are Stable
In Dec 2009, CPI-U stood at 215.949. One year ago in Dec 2008, CPI-U was at a level of 210.228. So the year-over-year inflation rate was 2.72%. The powers-that-be would like inflation to be between 2 and 3 percent, ideally about 2.5%. Anywhere between 0 and 5 percent could be considered stable prices. So this is pretty close to the unofficial target.
One way to think of this is that a Christmas present that cost $210.23 on Christmas 2008, cost $215.95 in Christmas 2009. So you had to fork over an extra $5.72 when you went Christmas shopping this year.
Month-over-Month Prices Decreased
Compared to the previous month, price levels actually came down. In Nov 2009 CPI-U was 216.330 and in Dec 2009 it is 215.949. That is a decrease of -0.18%. At an annual rate that would be -2.09%. (Annual rate means if the same rate were to continue for 12 months. Economists like to compare things at an annual rate. However, don’t expect the latest month-to-month rate to persist. It is common for the CPI-U to go up one month and down the next month.)
What is the CPI?
The Consumer Price Index (CPI) is a measure of the level of prices in the United States. It measures the cost of living. Data is collected by the Bureau of Labor Statistics (BLS) which is a branch of the Department of Labor. Every month, the BLS releases a report for the previous month.
There are two series, CPI-U and CPI-W. CPI-W is for all urban wage earners, which covers about 32% of all workers. This number is important because it is used to determine cost-of-living increases for social security recipients and is also built into wage increases in many union contracts.
CPI-U is the more widely used figure. CPI-U is for all urban consumers and covers 87% of all consumers. When people talk about inflation, they are usually referring to the annual rate of change of CPI-U.
Deflation
Since World War II, prices levels in the U.S. have normally risen which is what we call inflation. But sometime, like during the Great Depression in the 1930s, prices actually fall. Falling prices is called deflation. Looking at the chart of CPI-U over the past year, we have actually experienced some deflation as prices actually came down for a while. Year-over-year deflation seems to be a short-lived phenomenon.
Consumers and savers like deflation because it makes things cheaper to buy and the value of savings increases. But wage earners and debtors prefer inflation to deflation. Inflation reduces the value of debts and future obligations, and wage earners get raises which makes them feel wealthier, even if it is an illusion.
Since the U.S. government is the largest debtor in the world, naturally the government does not like to see deflation. They will fight it at all costs using whatever means they have at their disposal. Federal Reserve Chairman Ben Bernanke is famous for saying that, if necessary, the Federal Reserve will drop money from helicopters to fight deflation.
Inflation Expectations
The BLS release can tell us what inflation rate was in the past. But most people are interested in knowing what inflation will be in the future. Unfortunately, nobody knows. But everyone has some expectation of what inflation will be. Some economists have models which they use to forecast inflation. Most people will just look at the recent past and extrapolate out into the future. A 36-month simple moving average of year-over-year inflation rate is 2.13%.
There is a survey by the University of Michigan that asks consumers about their inflation expectations. The results are made available by the Federal Reserve Bank of St. Louis. You can see that consumers normally expect about 3% inflation. At the beginning of the recession in 2008, consumers initially were expecting high inflation, up to 5%. But then as prices fell, they lowered their expectations to 2%. Now their have settled in between 2% and 3%.
Bottom Line
At this time, inflation is well under control. The fears of deflation have abated and the inflation rate is right in the sweet spot. Ben Bernanke and the Fed deserve credit for this.
You can down a pdf file of the latest CPI News Release at the Bureau of Labor Statistics Consumer Price Index
Here is the University of Michigan Inflation Survey from the Federal Reserve Bank of St. Louis.
Charts are from economagic.com
