As a general rule, price increases across a broad spectrum of goods and services over a period of time are what economists call inflation. This increase can happen for a variety of reasons, including demand-pull and supply-push. When inflation is a problem, it means that consumers’ paychecks can’t keep up with the price of essentials. That’s why the Fed wants to keep a lid on prices, and one way it does so is by setting an annual inflation rate target of 2 percent.
Inflation rates are determined by comparing the average change in prices for a basket of goods and services to changes in a consumer’s spending patterns. In other words, the Bureau of Labor Statistics takes into account what a typical household buys and compares that to what they bought a year ago to determine how much prices are rising.
While the CPI is an important measure of inflation, it doesn’t take into consideration all the ways that consumers spend money. For example, some items are more seasonal—back-to-school or tax season, for instance—and those variations can skew the overall CPI results. That’s why the BLS also reports a “trimmed mean” and weighted median CPI, which try to smooth out those seasonal differences.
The CPI and the Department of Commerce’s personal consumption expenditures (PCE) index both have “core” measures that strip out price fluctuations for food and fuel. These volatile items make up a large part of household budgets, but their inclusion in a price index can muddy the long-run inflation signal, and that matters for institutions like the Fed charged with maintaining price stability.
About the Author
