Chapter 23 - Inflation

Report
Measuring Price Stability: The Consumer
Price Index
Mark Carney
Governor of The Bank of Canada
• Inflation refers to the general rise in prices from
year to year.
• Statistics Canada measures inflation using the
CPI, which tracks price changes in consumer
goods.
– To do this, a “basket” of over 600 goods and services
are sampled.
– These items are weighted according to how much the
typical household tends to buy in a particular
category.
• Inflation Rate= (CPI year 2 – CPI year 1) x 100
CPI year 1
• The Consumer Price Index (CPI) is an indicator of changes in
consumer prices experienced by Canadians.
• It is obtained by comparing, over time, the cost of a fixed basket of
goods and services purchased by consumers.
• Since the basket contains goods and services of unchanging or
equivalent quantity and quality, the index reflects only pure price
change.
• The CPI is widely used as an indicator of the change in the general
level of consumer prices or the rate of inflation.
• Since the purchasing power of money is affected by changes in
prices, the CPI is useful to virtually all Canadians.
•
Consumers can compare movements in the CPI to changes in their
personal income to monitor and evaluate changes in their financial
situation.
The consumer price index (CPI)
is the most common measure of inflation
monitors price changes in a representative
“shopping basket” of consumer products
includes quantities in a shopping basket
determined in a base year
compares prices in the current year with those in
the base year
Consumer Price Index and major components, Canada
Relative importance¹
%
All-items CPI
Food
Shelter
Household operations, furnishings and equipment
Clothing and footwear
Transportation
Health and personal care
Recreation, education and reading
Alcoholic beverages and tobacco products
100.00²
Consumer Price Index and major components, Canada
Relative importance¹
%
All-items CPI
100.00²
Food
15.99
Shelter
27.49
Household operations, furnishings and equipment
11.55
Clothing and footwear
Transportation
Health and personal care
Recreation, education and reading
Alcoholic beverages and tobacco products
5.31
20.60
4.95
11.20
2.91
Consumer Price Index and major components, Canada
Consumer Price Index and major components, Canada
Relative importance¹
May 2010
April 2011
May 2011
April to May 2011
May 2010 to May
2011
Not seasonally adjusted
%
All-items CPI
(2002=100)
% change
100.00²
116.3
119.8
120.6
0.7
3.7
Food
15.99
122.9
126.9
127.7
0.6
3.9
Shelter
27.49
123.0
125.2
125.2
0.0
1.8
Household operations,
furnishings and
equipment
11.55
108.6
109.8
110.4
0.5
1.7
Clothing and footwear
5.31
92.7
93.1
93.7
0.6
1.1
20.60
118.1
127.2
128.9
1.3
9.1
4.95
114.6
117.3
117.2
-0.1
2.3
Recreation, education
and reading
11.20
103.6
105.1
106.1
1.0
2.4
Alcoholic beverages
and tobacco products
2.91
132.1
135.0
135.7
0.5
2.7
Transportation
Health and personal
care
The Measurement of Inflation
• Inflation is measured by changes in the price
level.
• There are 3 types of price indexes:
• The Consumer Price Index measures price
changes in consumer goods.
• The Wholesale Price Index measures price
changes in primary goods.
• The Implicit Price Deflator measures changes in
the average price level of all final goods.
Consumer Price Index Weights (2002)
• The CPI allows one to compare, in percentage terms,
prices in any given time period to prices in the official
base period which, at present, is 2002=100.
• The official time base was changed from 1992=100 to
2002=100 starting with the CPI for May 2007.
• The change is strictly an arithmetic conversion, which
alters the index levels, but leaves the percentage
changes between any two periods intact, except for
differences in rounding.
INFLATION TARGETS
• The Bank of Canada aims to keep inflation at the
2 per cent target, the midpoint of the 1 to
3 per cent inflation-control target range.
• This target is expressed in terms of total CPI
inflation, but the Bank uses a measure of core
inflation as an operational guide.
• Core inflation provides a better measure of the
underlying trend of inflation and tends to be a
better predictor of future changes in the total
CPI.
Rule of 70 – Used to estimate GDP growth
or Inflation
• Approx. # of years required to double inflation
• INFLATION
• With a 3 percent annual rate of inflation the price
level will double in about 23 years (70÷3=23)
• Inflation of 8 percent per year will double the
price level in about 9 years (70÷8 = 9).
Limitations of the CPI
• Category weightings- do they reflect a “typical” household
• Items in Base Year basket- may not be realistic e.g. may
have been replaced with a new technology.
• Cultural Diversity- are not taken into account
•
The CPI does also does not take full account of
– consumer differences, since it is based on the consumption
patterns of an average household
– changes in spending patterns since it uses base-year quantities
– improvements in product quality
Anticipated Inflation
• Represents the level of inflation people expect to occur and
have built into their economic decisions
• Wage contracts and long-term loan contracts are usually
the source for judging the expected (anticipated) inflation
rate
• Economic costs include:
– Transaction costs – or “boot-leather costs” b/c people run
around trying to avoid losses from the declining value of money
– distortion of incentives from the tax system ex. Anticipated
inflation increases the the $ return on investments. As these
dollar returns are taxed, the tax rate rises
– the uncertainty of how and when policy makers will respond to
the high level of inflation
Unanticipated Inflation
• Is the level of inflation that is not expected or
is unforseen
• Causes economic costs because people have
not adjusted their earnings and expenditures
for this level of inflation
Winners and Losers of Unanticipated
Inflation
The Winners
• Inflation results in a redistribution of wealth.
• Debtors and producers of goods and services
benefit from inflation
The Losers
• Those who lose as a result of inflation include
creditors, people on fixed incomes, and owners of
financial assets.
WINNERS & LOSERS OF UNANTICIPATED INFLATION
WINNERS
• Debtors(borrowers) because they repay later with $ that are worth less
• Producers(sellers) because selling prices rise faster that input costs and
therefore more profit; buy inputs now at current costs – sell for higher
prices
• Real Estate Owners because Real estate value will increase over time
LOSERS
• Creditors (lenders) because when they are repaid, the $ will lose
purchasing power; the money that is paid back later is worth less in
purchasing power
• People on Fixed Income because their income remains the same but
prices rise (Unless the income is indexed)
• Owners of Financial Assets because the real value of financial assets will
decrease over time

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