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Ed Dolan’s Econ Blog What Does the CPI Measure? Inflation or the Cost of Living? What’s the Difference? July 23, 2014 Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.

Consumer Prices Increase at 3.13
Percent Annual Rate in June  The U.S. consumer price index rose at a seasonally adjusted rate of 3.13 percent in June 2014, the fourth consecutive month over 2 percent  What do these data mean? Do they show inflation or an increase in the cost of living? What is the difference? How can we tell? July 23, 2014 Ed Dolan’s Econ Blog

“Cost of Living” vs. “Inflation”
 An increase in the cost of living means it gets harder to maintain a constant standard of living on a given income.  Inflation, in contrast, means a change in the value of the dollar as a unit of account.  Over time, inflation affects all transactions, raising incomes along with prices, so it does not necessarily signal a change in the real cost of living July 23, 2014 Ed Dolan’s Econ Blog

The CPI as a Measure
of Cost of Living  The Consumer Price Index (CPI) is a weighted average of prices of goods bought by the typical urban consumer. It is a measure of the cost of living  Usually it is reported with seasonal adjustment (SA) for predictable variations in prices, like cheaper vegetables during harvest season  However, a version without seasonal adjustment (NSA) is a better indicator of short-run changes in the cost of living July 23, 2014 Ed Dolan’s Econ Blog

Core Inflation  To identify
underlying trends in inflation, economists try to filter out changes in the CPI that arise from short-term, microeconomic causes like weather and military conflicts  One way to do that is to exclude prices of food and energy, which are very volatile and do not always reflect longer-term macroeconomic trends  The result is the core CPI, which, as shown here, is much less variable from month to month July 23, 2014 Ed Dolan’s Econ Blog

The 16-Percent Trimmed Mean Inflation
Rate  The 16 percent trimmed mean inflation rate is a more accurate way to identify the underlying trend of inflation  Instead of always excluding food and energy, it excludes the 8 percent of prices that increase most in a given month and the 8 percent that increase least or decrease most  The long-term trend of the trimmed- mean inflation rate is the same as that for the CPI, but it varies much less from month to month July 23, 2014 Ed Dolan’s Econ Blog

Little Change in Expected Inflation
 In addition to watching current data on inflation trends, like the core and trimmed mean versions of the CPI, policymakers also watch expected inflation rates  This set of estimates shows that expected inflation has been inching higher July 23, 2014 Ed Dolan’s Econ Blog

The Bottom Line: Too Soon
to Sound the Inflation Alarm  The Federal Reserve has set a target of 2 percent inflation, as measured by the Personal Consumption Deflator, equivalent to about 2.5 percent inflation for the CPI  The latest data on current and expected inflation show that the economy may be edging toward the Fed’s target, but is not there yet July 23, 2014 Ed Dolan’s Econ Blog

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