Inflation is an increase in the price of goods and services or a decline in the purchasing power of money. Annual Inflation rates are calculated monthly by the U.S. Bureau of Labor Statistics (BLS) from the Consumer Price Index (CPI-U), which includes 80,000 good and services.
Types of Inflation
- Price Inflation is when prices get higher or it takes more money to buy the same item.
- Monetary Inflation is an increase in the money supply commonly referred to as the government (printing money) which generally results in price inflation.
Calculation the annual inflation rate of a loaf of bread:
- January 2014 – cost of loaf of bread is $1.00
- January 2015 – cost of loaf of bread is $1.02
- 1.02 – 1.00 / 1.02 = .02 X 100 =
- 2% inflation rate of a loaf of bread over this 12 month period.
The Federal Reserve System, the central banking system of the United States which meets 8 times a year, utilizes the BLS statisics to attempt to control inflation and deflation and sustain an annual inflation ratio of about 2%. They do this by:
- Managing the nation’s money supply through monetary policy to achieve the sometimes-conflicting goals of maximum employment
- Stabilizing prices, including prevention of either inflation or deflation
- Controlling long-term interest rates. For example, since 2008 interest rates have been kept low in order to increase consumer spending and stimulate economic growth.
What Can Increase Inflation:
- Increases in the money supply. Long Term.
- Temporary shortage of goods, either due to a natural disaster like Hurricane Katrina and Hurricane Sandy. Short Term.
- The effects of an organized cartel that is purposely restricting supply and artificially raising prices. Short Term. For instance, in 2008, OPEC exerted its influence by cutting production and driving up prices.
- Too much money, not enough goods
- Company’s costs go up so they increase prices.
What are the Impacts of Healthy Inflation
- Interest Rates go up
- Employment goes up
- Sign of growing/good economy
Deflation or low inflation caused by
- Productivity induced – such as when there are major productivity enhancements like the invention of the assembly line or the completion of the transcontinental railroad or the onset of cheap productive capacity in China.
- Collapsing stock market which destroy paper assets – 2008
- Plugging oil prices
- Reduction in supply of money
- Reduction in available credit
- When the GDP is growing fast in terms of real money
What is the impact of deflation or low inflation
- weak economy
- falling prices
- shrinking employment
- shrinking income
- lack of spending power
Rapidly rising or falling inflation often a sign of suffering economy with high unemployment and a lack of spending power.
Consumer Price Index is a measure of change in consumer goods and services. Producer Price Indexes (PPI) often will increase before CPI.
The government chose an arbitrary date to be the base year and set that equal to 100. Currently that date is the average of the years 1982-1984; previously the base year was 1967. Index numbers are not dollar values, but measures of the change over time relative to their base period value of 100.0.
The Consumer Price Index (CPI) is published as an index number that shows the change in the price of a defined market basket of goods and services over time from a base period which is defined as 100.0. An increase of 7 percent from that base period, for example, is shown as 107.0. Alternately, that relationship can also be expressed as the price of a base period “market basket” of goods and services rising from $100 to $107. Currently, the reference base for most CPI indexes is 1982- 84=100 but some indexes have other references bases. The reference base years refer to the period in which the index is set to 100.0. In addition, expenditure weights are updated every two years to keep the CPI current with changing consumer preferences.