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Inflation

What is inflation?

Inflation has been defined as a process of continuously rising prices, or equivalently, of a continuously falling value of money. In other words, inflation causes the buying power of a dollar to decrease over time. A 15 cent hamburger in 1966 seems to us a lot cheaper than the 79-cent hamburger of today. But when the price of that 1966 burger is adjusted for inflation, the price is comparable.

To experiment with the change in buying power of a dollar over time, try out the on-line inflation calculator maintained by the U.S. Bureau of Labor Statistics (BLS). The CPI inflation calculator uses the average Consumer Price Index for a given calendar year. This data represents changes in prices of all goods and services purchased for consumption by urban households. This index value has been calculated every year since 1913. For the current year, the latest monthly index value is used.

How is inflation measured?

Various indexes have been devised to measure different aspects of inflation. Two commonly used indexes are the Consumer Price Index (CPI) and the US Implicit Price Deflator for Personal Consumption (IPD). The CPI measures inflation as experienced by consumers in their day-to-day living expenses. The method used to construct the CPI compares the current and base year cost of a basket of goods and services of fixed composition. For the CPI the base is a fixed "market basket" or bundle of goods and services representative of the purchases of urban consumers. The index is the ratio of today's cost of the fixed bundle to the base year cost of the same bundle. This kind of index implicitly assumes that the consumer's consumption pattern does not change in response to any price changes.

The alternative index to the CPI is the implicit price deflator for personal consumption (IPD). This price index uses current period quantities as the weights rather than some fixed bundle. Current personal consumption is measured in today's prices and then compared to current personal consumption at prices from a base year. This price index method assumes that the consumer has made allowances for changes in relative prices.

There are a number of other indexes of price changes other than the CPI and IPD: the Producer Price Index (PPI) measures inflation at earlier stages of the production and marketing process; the Employment Cost Index (ECI) measures it in the labor market; the Bureau of Labor Statistics' International Price Program measures it for imports and exports; and the Gross Domestic Product Deflator (GDP-Deflator) measures combine the experience with inflation of governments (Federal, State and local), businesses, and consumers. Finally, there are specialized measures, such as measures of interest rates and measures of consumers' and business executives' inflation expectations.

What measure of inflation should I use?

The "best" measure of inflation for a given application depends on the intended use of the data. The CPI is the most commonly used measure for adjusting payments to consumers when the intent is to allow consumers to purchase, at today's prices, a market basket of goods and services equivalent to one that they could purchase in an earlier period. It is widely used to index wages, benefits, taxes and transfers. Also, the CPI makes comparison between years other than the base year easy because the types and quantities of the goods and services consumed are fixed.

The IPD measures the prices of a much wider group of goods and services than the CPI. For example, the IPD includes all consumption of health care rather than just out of pocket expenses and consumer purchased insurance measured in the CPI. The IPD is based on current economic conditions and consumer expenditures, tastes and preferences. It is frequently used to adjust state economic and revenue data. The state expenditure limit is based on the IPD as well as inflation adjustments in the state's biennial budget.

What is the measure of inflation for Washington?

There are no inflation indexes for the state of Washington.

Besides monthly publication of the national (or U.S. City Average) Consumer Price Index, the US Bureau of Labor Statistics (BLS) publishes monthly indexes for the four regions – Northeast, Midwest (formerly North Central), South, and West. Monthly indexes are also published for urban areas classified by population size--all metropolitan areas over 1.5 million, metropolitan areas smaller than 1.5 million, and all non-metropolitan urban areas. Indexes also are available within each region, cross-classified by area population size. For the Northeast and West, however, indexes for non-metropolitan areas are not available. BLS also publishes indexes for 26 local areas. Local area indexes are byproducts of the national CPI program.

Each local index has a much smaller sample size than the national or regional indexes, and is, therefore, subject to substantially more sampling and other measurement error. As a result, local area indexes are more volatile than the national and regional indexes. Therefore, BLS strongly urges users to consider adopting the national or regional CPI's for use in escalator clauses. If used with caution, local area CPI data can illustrate and explain the impact of local economic conditions on consumers' experience with price change.

Where can I get more information?

Values of the Consumer Price Index (CPI) and the U.S. Implicit Price Deflator for Personal Consumption (IPD) are published by the Office of the Forecast Council in the quarterly economic and revenue forecast publication, which contain the following tables:

A comprehensive discussion of the Consumer Price Index is available at the U.S. Bureau of Labor Statistics (BLS) website.

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