David Gillies, Melissa Phillips, Chad Ruter, and Pat Warren
University of Sioux Falls
Consumer Price Index
The consumer pricing index (CPI) is a measure of the price level of consumer goods and services. The U.S. Bureau of Labor Statistics began calculating and issuing the monthly calculation in 1919. The CPI is calculated by observing price changes among a wide range of products and weighing these price changes by the share of income consumers spend to purchase them. The CPI focuses on approximating a cost of living index and can be used to evaluate our currency and prices. CPI is defined as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services” (Federal Reserve Bank, 2010). The consumer pricing index can be used for three things “(1) as a Cost of Living Index (COLI); i.e., as a measure of the relative cost of achieving the standard of living when facing two different sets of prices for the same group of commodities; (2) as a consumption deflator; i.e., the price change component for a decomposition of a value ratio into price and quantity components and (3) as a measure of general inflation” (Federal Reserve Bank, 2010). The CPI is used to understand whether the economy is experiencing a period of inflation or deflation, as well as the severity of the upturn or downturn. “Economists generally agree that deflation is a widespread fall in prices, as measured by the consumer price index” (Gross, 2010). To be considered deflation the consumer price index would need to decline for at least one year. For consumers, a fall in prices may sound like a benefit, but in fact, the ripple effect of deflation can include increased unemployment rates, instability in the stock market, decreased home values, and a general decline in the economy. Businesses tend to minimize their investments during a period of deflation to prevent severe losses. As businesses invest less, they may also reduce their payroll by laying off personnel, reducing incentive based compensation programs, or cutting salaries. This has an impact on consumer ability to pay off fixed rate loans such as mortgages, which in turn impacts the financial services industry. In contrast, consumers may find some benefits from a period of deflation as the cost of goods they purchase drop. “In episodes of sustained deflation, as prices fall, the buying power of cash increases” (Christensen, 2009). The consumer pricing index can be used to compare our current recession to the Great Depression of the 1930s. During the great depression prices fell on average of fifteen percent. “This deflation was driven by a decline in output, demand, and credit – too little money and wages chasing too many goods and workers” (Gross, 2010). The United States is once again experiencing a period of deflation based on data collected over the past three years. In 2008 the US had four straight months of a declining consumer price index in the months of August to December. The consumer price index had at least one month of downturn in both 2009 and 2010. In the last few months it has stayed right around zero but did have a slight decline in June. Deflation is usually seen when unemployment numbers are high and business output slows, Christensen (2009). The current economy is experiencing high rates of unemployment with a current national rate of 9.5%. The level of deflation the US has experienced over the past few years has taken its toll, but it is not as severe as what was experienced during the Great Depression. Experts usually agree that slight inflation is a good thing that fuels the economy. Gross (2010) states “Experience shows that a rate of inflation around 2 or 3 percent helps the economy perform at full potential with maximum sustainable employment”. In fact even the Federal Reserve wants the rate of inflation to be positive. “One Federal...