Table of Сontents
- Inflation Basics
- How Is Inflation Calculated?
- CPI Inflation Rate Formula
- Finding Inflation Rate With PCE
- What Does Inflation Mean for the Workforce?
- What Does Inflation Mean for Investors?
- How Inflation Impacts Monetary Policy
- What is the Current Inflation Outlook?
- Bottom Line
Two distinct US government organizations track and quantify inflation, which is an increase in the monthly cost of a basket of consumer goods and services. Learn the differences between the two methods for calculating inflation.
Inflation Basics
Essentially, inflation is the change in the cost of consumer goods and services over time. Monthly tracking and annualized prediction are provided. The computation is based on a representative basket of goods and services, which is maintained over time with the exception of sporadic adjustments to account for long-term changes in consumer purchasing trends. Additionally, it is defined so that it represents the average change in prices across various US areas.
How Is Inflation Calculated?
The Bureau of Labor Statistics (BLS) and the Bureau of Economic Analysis are two different federal agencies that monitor inflation (BEA). Despite using comparable approaches and attempting to depict the same notion, their data is slightly different, which means that their calculations may also differ significantly.
- CPI: The BLS tracks what real purchases are made by Americans to determine inflation in the Consumer Price Index (CPI). Every three months, it polls about 24,000 customers and collects data from an additional 12,000 people who keep annual purchase diaries.
- PCE: The BEA, in contrast, determines personal consumption expenditure (PCE) inflation and obtains its statistics from the businesses that sell the goods.
- PPI: The BLS keeps track of information on consumer goods pricing derived from the first business transaction. As a result, it follows prices further up the manufacturing chain than the PCE, which focuses on the last transaction—the one with the final customer.
CPI Inflation Rate Formula
Despite their apparent similarity, there are some differences between CPI and PCE. For instance, substitution is typically not taken into account in the CPI calculation. When a food item’s price increases, for example, consumers start choosing an alternative. The supply and demand equilibriums for the two goods may be impacted by this.
Indirect cost inclusion is another variation between CPI and PCE methodologies. Some consumer products and services are not bought by customers directly. Medical expenses are one example, which is typically covered by health insurance.
The table that follows contrasts the PCE and CPI methods of estimating inflation.
| CPI | PCE | |
| Origin | BLS | BEA |
| Methodology | Data on the same basket of goods & services tracked monthly and annualized | Data on the same basket of goods & services tracked monthly and annualized |
| Data Source | Consumers | Businesses |
| Substitution | Not reflected in CPI | Reflected in PCE |
| Indirect expenses | Not reflected in CPI | Reflected in PCE |
Finding Inflation Rate With PCE
The PCE method to inflation may theoretically be expanded to include all products and services sold in the US, which is by definition the gross domestic product, as it examines what firms charge for specific goods and services (GDP). So using the GDP as a measure of inflation is still another method.
Comparing the nominal GDP with the real GDP for the same time period achieves this. The total value of all products and services is known as the nominal GDP, whereas the real GDP is simply the value after inflation. The GDP “deflator,” an inflation rate that is indexed back to a chosen base year, is obtained by dividing nominal GDP by real GDP. This ratio is obtained by multiplying the result by 100.
What Does Inflation Mean for the Workforce?
Consumers are concerned about inflation because it affects their salaries since it measures how much the cost of the goods and services they purchase each year rises in price. Consumers anticipate that their earnings will grow by at least that much to maintain their purchasing power, even if some inflation (although a very minor level like 1-2%) is a feature of a properly operating economy.
Many corporations, labor unions, and governmental organizations keep a careful eye on the inflation rate and factor it into their annual compensation projections. Some employers promise to boost salaries by an amount that is at least equivalent to the annual rate of inflation.
What Does Inflation Mean for Investors?
Investors anticipate annual asset growth that covers both inflation and the “risk premium” associated with the investment. The amount of return needed by an investor to compensate for the investment’s inherent financial risk is known as the risk premium. Investors expect higher returns on their assets when inflation rises, albeit they cannot always rely on receiving them.
How Inflation Impacts Monetary Policy
As part of its monetary strategy, the Fed keeps an eye on inflation. Although it isn’t the main objective of monetary policy, inflation is a significant one. The Fed will typically prefer the economy to experience modest, stable inflation. A rate of inflation that is too high runs the risk of overheating the economy and causing runaway inflation. Deflation or negative inflation is also undesirable. In order to maintain low, stable inflation, the Fed employs its monetary policies, such as establishing bank reserve rates and short-term interest rates.
What is the Current Inflation Outlook?
As of January 31, 2022, the inflation rate was 7.48 percent, which is the highest monthly number since February 1982. Only 1.4 percent and.99 percent were the figures for January 2021 and 2020, respectively.
| Time | Interest Rate |
| January 2022 | 7.48% |
| January 2021 | 1.4% |
| January 2020 | 0.99% |
Depending on your source, the forecast will vary greatly, especially in light of the most recent rise at a 40-year high. The pandemic’s impact on the supply chain, which led to price increases for numerous commodities, looks to be a significant factor. There is no certainty as to when the supply chain will resume its usual operation, although it is commonly anticipated that inflation will start to decline considerably. New COVID-19 variations also pose the potential to broaden the pandemic, adding to the uncertainties.
Tip: While inflation is a worry, you won’t be able to control it, therefore planning for some degree of inflation is more important than knowing with certainty what rate it will be in the coming year or two.
Bottom Line
After a multi-decade sabbatical, everyone is thinking about inflation again, and the Fed, investors, employers, and consumers are all worried about it. The best course of action is to budget for it in purchases, investments, and earnings because there is nothing we can do to change it.
