The consumer price index is a measure of the cost of living--how hard it is to maintain a given standard of living on a given income. Inflation means a long-term trend in the value of the unit of account that affects incomes as well as prices. By adjusting the CPI to remove transient price changes, economists can better identify the underlying inflation trend

1. Data for your Classroom from
Ed Dolan’s Econ Blog
What Does the CPI Measure?
Inflation or the Cost of Living?
What’s the Difference?
July 23, 2014
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2. 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

3. “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

4. 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

5. 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

6. 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

7. 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

8. 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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