Consumer Price Index (CPI): Comprehensive In-Depth Analysis

Federal Reserve Chairmain, Ben Bernanke, recently stated an explicit target of 2% inflation per year. Bernanke has a dual mandate of controlling inflation and supporting job growth. Bloomberg has an article today, which notes that many economists are skeptical of the 2% target, and are predicting higher inflation as Bernanke likely focuses on job growth over inflation concerns. ValueWalk has produced a comprehensive analysis of the metric used by the Government to track inflation; Consumer Price Index (CPI). We believe this article discusses some ideas on the subject which have never been researched.

The Consumer Price Index is as useless a measure of pricing dynamics as new jobless claims is a measure of unemployment.   Each compiles data into a broadly logical scheme, but both fall short of telling us what we need to know.

In the case of CPI, understanding variances in what consumers pay for goods and services is necessary to deriving inflation, and to exploring other concepts such as purchasing power and cost of living.  The calculation is smarter than it used to be, but are current formulas really good enough?

They might not be.   Between scrutiny of the market basket and the role of technology in changing the way companies are setting prices, it’s not clear that CPI gets us close to a useful understanding of pricing dynamics.  Yet, to let statistics with questionable relevance and accuracy influence our macroeconomy to so great a degree is to play a dangerous game with Americans’ income and world markets.

What the CPI Measures

The Bureau of Labor Statistics describes the CPI as the “product of a series of interrelated samples,” representing “all goods and services purchased for consumption by the reference population,” and “developed from detailed expenditure information provided by families and individuals on what they actually bought.”  Expenditures are classified into eight major categories: Food and Beverage, Housing, Apparel, Transportation, Medical Care, Recreation, Education, and Other Goods and Services.  Under these eight umbrellas, prices for some 200 goods are harvested.

The goods that are measured are meant to be seen as common goods and include items such as breakfast cereal, coffee, rent, mortgage payments, women’s dresses, airfare, prescription drugs, televisions, postage, college tuition, tobacco, funeral expenses, and many more.  Taxes directly related to the purchase of goods and services are included in the measure, as are government user fees, yet other taxes impacting consumer purchasing power (such as income taxes or Social Security taxes) are not taken into account.

Why the CPI Is Important

Even if you don’t wait with bated breath for new CPI numbers to release (and a lot of people do), I’ll bet you pay attention to inflation.  And even if your interest in new inflation rates is mild at best, I’m certain you care about the cost of borrowing or what returns you can expect when you decide to invest your money.  CPI impacts all of our lives to the extent that it is a key component of the inflation calculation, and to the extent that inflation metrics are key influencers of Federal Reserve policy.