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WhatsinYourMarketBasket?WhyYourInflationRateMightDifferfromtheAveragePageOneEconomicsSt.LouisFed

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OCTOBER2015

WhatsinYourMarketBasket?WhyYour
InflationRateMightDifferfromtheAverage
byScottA.Wolla

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whyyourinflationratemightdifferfromtheaverage.pdf)
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Inflationiswhenyoupayfifteendollarsforthetendollarhaircutyouusedto
getforfivedollarswhenyouhadhair.
SamEwing,Formerprofessionalbaseballplayer
Doesadollargoasfarasitusedto?Itmightseemthatyourepayinghigher
andhigherpricesforthegoodsyoubuy.However,thedatashowthatinflation
hasbeenvirtuallynonexistentformuchof2015.Andtheinflationratehasbeen
lowerthantheFederalReserve's2percentinflationgoalformorethan3years.1
Nevertheless,whenmanypeoplehearreportsoflowerthanaverageinflation
rates,theymaynotfeelitreflectstheirexperienceasconsumers.Whereisthe
disconnectbetweentheexperienceofindividualsandwhatthedatashow?

WhatIsInflation?

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Generallyspeaking,inflationmeanstheaveragelevelofpricesisrising.More
specifically,inflationisageneral,sustainedupwardmovementofpricesfor
goodsandservicesinaneconomy.Priceshavetendedtoriseovertime,which
meansthattheinflationrate(thepercentageincreaseintheaveragepricelevel
ofgoodsoveraperiodoftime)hasbeenpositive.And,aspricesrise,the
purchasingpowerofeachdollardiminishes.A2percentinflationratemeans
that(onaverage)adollarbuys2percentfewergoodsandservicesthanitdid
lastyear.Youmightbesurprisedtodiscoverthatevenafteraccountingforthe
effectofrisingprices(inflation),averageincomeshaverisenovertime.2So,
whileitstruethatpricesgenerallyriseovertime,sodopeoplesincomes,which
usuallyallowsthemtopurchasemoregoodsandservices.
Eventhoughyourarelyfindpeoplediscussingrisingpricesasaneconomic
benefit,mosteconomistsbelievethatalowandstablerateofinflationis
beneficialfortheeconomy.3Tothisend,manycentralbankshaveamandateof
pricestability,whichmeanstheyaredirectedtointentionallygeneratealow
andsteadyrateofinflation.TheFederalReserveSystem,thecentralbanking
systemoftheUnitedStates,hasadualmandateofpricestabilityand
maximumemploymentandhasinterpretedpricestabilityasa2percentinflation
objective.4

HowIsInflationMeasured?
Inflationcanbemeasuredinavarietyofways,dependingonwhichbasketof
pricesismeasuredandhowthosepricesareweighted.Themostwidelyreported
measureofinflationistheconsumerpriceindex(CPI).TheCPImeasuresthe
averagechangeovertimeinthepricespaidbyurbanconsumersforamarket
basketofconsumergoodsandservices.ThecurrentCPImarketbasketwas
constructedbasedoninputfromspendingdiarieskeptby28,000consumers
andanother60,000quarterlyinterviewsconductedin2011and2012.Allthis
informationwasusedtodeterminewhatpeoplewereactuallybuying.5Data
collectorsvisitplacesofbusinesstocollectpriceinformationmonthlytorecord
thepricesofabout80,000itemsthatmakeupthemarketbasket.6Thepricesof
goodsandservicesinthemarketbasketarethenindexedtomakeiteasierto
comparechangesinthepriceofthemarketbasketovertime.Todothis,the
BureauofLaborStatisticssetsthepriceofthemarketbasketduringaparticular
timeperiodequalto100.Changesintheindexvalueareusedtomeasure
inflationandcalculatetheinflationrate.Forexample,iftheindexrisesfrom100
to103inayear,theinflationrateforthat1yearperiodis3percent.Also,
noticetheuseofthewordurbantheCPIismeanttoreflectthepurchasesof
thetypicalurbanconsumer,whichrepresentsabout87percentoftheU.S.
population.7,8Peoplewholiveinruralnonmetropolitanareas,farmfamilies,
peopleinthearmedforces,andthoseininstitutionsarenotincludedinthe
calculationtherefore,theCPIdoesnotattempttoreflectpricechangesfor
theseconsumers.
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WhatsinYourMarketBasket?WhyYourInflationRateMightDifferfromtheAveragePageOneEconomicsSt.LouisFed

YourPersonalInflationRate
Statisticsareoftenreportedasanaverage,butthataveragemightnotreflect
theexperienceofanygivenindividualinthesample.Forexample,theaverage
ageofapersonlivingintheUnitedStatesis37.6years9andtheaverageincome
is$46,163(personalincomepercapita).10Areyou37.6yearsoldwithan
incomeof$46,163?Chancesareyoudontfitthisaverageexactly.Similarly,
yourpersonalinflationratewilllikelydifferfromtheCPIinflationrate.TheCPI
marketbasketisanaveragecalculatedtoreflectthespendingoftheaverage
urbanhousehold,notanyspecificindividualhousehold.
Becauseeachindividualbuysadifferentbasketofgoodsandservices,potentially
everypersonhashisorherowninflationrate.Yourpersonalinflationrate
dependsonhowyouspendyourmoney.Forexample,letsassumeyouhitthe
averagepersonmarkfairlyclosely:Youareabout37.6yearsold,bornon
January1,1978.Duringyourlifetime,thepricesofallitemsintheCPImarket
baskethaverisenapproximately278percent(anaverageannualrateof3.7
percent).However,whenseparatedintocategories,medicalcarehasrisen653
percent(anaverageannualrateof5.6percent),whileapparelhasrisenonly57
percent(anaverageannualrateof1.3percent)sinceyourbirth.Youcanlikely
seehowyourindividualmarketbasketinfluencesyourpersonalinflationrate
(seethefigure).Ifyouhavespentalargerportionofyourincomeonmedical
care,forwhichtheaveragepricehasrisenfasterthanmostprices,yourpersonal
inflationratehasbeenhigherthantheCPIinflationrate.Ontheotherhand,if
yourtwinsisterhasspentalargerportionofherincomeonclothes,forwhich
theaveragepricehasrisenmoreslowlythanmostprices,herpersonalinflation
ratehasbeenlowerthantheCPIinflationrate.

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NOTE:Asstatedintheessay,theaverageageofindividualsintheUnitedStatesis37.6years.
AssumeherethattheaveragepersonwasbornonJanuary1,1978.UsingFREDtosetthe
indexat100onthatdate,pricesofallitemsintheCPImarketbaskethaverisenapproximately
278percent(blueline).However,whenseparatedintocategories,medicalcarehasrisen653
percent(redline),whileapparelhasrisenonly57percentoverthatperiod(greenline).
SOURCE:FRED,FederalReserveEconomicData,FederalReserveBankofSt.Louis.Consumer
PriceIndexforAllUrbanConsumers:AllItems,MedicalCare,Apparel
https://research.stlouisfed.org/fred2/graph/?g=1AxN
(https://research.stlouisfed.org/fred2/graph/?g=1AxN).

TheEverydayPriceIndex
TheEverydayPriceIndex(EPI),publishedbytheAmericanInstituteofEconomic
Research(AIER),isdesignedtoreflectpricechangesforthegoodsandservices
peoplebuyfrequentlyatleastoncepermonth.TheindexusestheCPIbut
simplypullsthegoodsandservicespurchasedonadaytodaybasisoutofthe
CPIbasketandputsthemintotheEPIbasket.Inotherwords,itcreatesa
smallermarketbasketthatincludesonlytheseeverydaygoodsandservices.
NotethattheEPIisnotmeanttoreflecttotalconsumerspendingrather,itis
meanttoreflectthepricechangesfeltbyAmericansonadaytodaybasis.11
TheAIERtracksandreportsmonthlyontheinflationrateofthismarketbasket.
TheEPIfocusesonpurchasesthatconsumerscannoteasilypostponeorforgo
(suchasfood,fuel,andprescriptiondrugs).Consumersmustabsorbthe
fluctuationsinpricesastheyhappen.ThelargestcategoriesintheEPIbasket
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(comprisingnearlyhalf)arefoodathome(21.5percent),foodawayfromhome
(15.1percent),andhouseholdfuelsandutilities(13.4percent).12Bycontrast,
theBLSgivesthosesamecategoriesmuchlowerweightsintheCPImarket
basket:foodathome(8.4percent),foodawayfromhome(5.8percent),and
householdfuelsandutilities(5.2percent).13Goodssuchascars,appliances,and
furniturearenotincludedintheEPIsimplybecausetheyarenoteveryday
goods.Theyarepurchasedinfrequently,orconsumerscansometimesdelaythe
purchaseofthesegoods.14TheEPIalsoexcludesgoodswithpricesfixedby
contract,suchasmortgageandrentpayments,becauseconsumersare
protectedfrompriceincreasesduringthecontractperiod.Thissmallermarket
basketismorevolatilethanthemuchlargerCPImarketbasket.Overthepast
20years,theEPIindicatesthateverydaypriceshaverisenby76percent(an
averageannualrateof3.2percent),whiletheCPIindicatesthatpriceshave
risenby56percent(anaverageannualrateof2.3percent).TheEPImightbe
helpfulinexplainingthedifferencebetweentheactual(lowerthanaverage)
inflationrateandtheperceptionbymanypeoplethatpricesarerisingquickly.
Differencesinthevisibilityofcertainpricesmightalsoimpactyourperceptionof
inflation.Formoreinformation,seetheboxedinsert,PerceptionandVisible
Prices.

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Conclusion
TheCPIisdesignedtoreflectthepurchasesofthetypicalurbanconsumer,and
notallpeoplearetypicalorurban.Moreimportantly,theCPIismeanttoreflect
theexperienceoftheaveragehousehold,butdifferencesinindividualconsumer
choicesnearlyguaranteethattheinflationrateexperiencedbyanyindividual
variesfromtheaverageinflationrate.Inaddition,thepricesofsomegoodsthat
aremorevisiblemightinfluencepeoplesperceptionofinflationbecausethe
pricesarebothnoticeableandvolatile.Inshort,itisgoodtorememberthat
whenitcomestonationalstatisticssuchastheCPI,actual(individual)results
mayvary.

Notes
1

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1 InflationMissesFeds2%Targetfor38thStraightMonth.RealTimeEconomics(blog),Wall

StreetJournal,August3,2015http://blogs.wsj.com/economics/2015/08/03/inflationmisses
feds2targetfor38thstraightmonth/(http://blogs.wsj.com/economics/2015/08/03/inflation
missesfeds2targetfor38thstraightmonth/).
2 RealdisposableincomepercapitaintheUnitedStateshasincreasedby221percentsinceApril

1960(seehttps://research.stlouisfed.org/fred2/graph/?g=1sPx
(https://research.stlouisfed.org/fred2/graph/?g=1sPx)).
3 Economistspreferasmallinflationbuffertoreducetheriskofdeflation.Foramoredetailed

discussionofinflationinthecontextofpricestability,seeWolla,ScottA.MoneyandInflation:A
FunctionalRelationship.FederalReserveBankofSt.LouisPageOneEconomicsNewsletter,
March2013https://research.stlouisfed.org/publications/page1econ/2013/03/01/moneyand
inflationafunctionalrelationship/(https://research.stlouisfed.org/publications/page1
econ/2013/03/01/moneyandinflationafunctionalrelationship/).
4 BoardofGovernorsoftheFederalReserveSystem.PressRelease.January25,2015

http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm
(http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm).Note:Whilethe
FederalReserveconsidersmanymeasuresofinflationinitsassessmentoftheeconomy,its
inflationobjectiveisstatedintermsofthepersonalconsumptionexpenditurespriceindex
(PCEPI).
5 U.S.BureauofLaborStatistics.ConsumerPriceIndex.FAQs:Question6.Updated

September17,2014http://stats.bls.gov/cpi/cpifaq.htm#Question_6
(http://stats.bls.gov/cpi/cpifaq.htm#Question_6).
6 U.S.BureauofLaborStatistics.ConsumerPriceIndex.FAQs:Question8.Updated

September17,2014http://stats.bls.gov/cpi/cpifaq.htm#Question_8
(http://stats.bls.gov/cpi/cpifaq.htm#Question_8).
7 U.S.BureauofLaborStatistics.ConsumerPriceIndex.FAQs:Question3.Updated

September17,2014http://stats.bls.gov/cpi/cpifaq.htm#Question_3
(http://stats.bls.gov/cpi/cpifaq.htm#Question_3).
8 TheFederalReserveBankofAtlantaoffersaCPItoolthatmaymoreaccuratelyreflectan

individualhouseholdsmarketbasket.ItsmyCPItoolallowsyoutotrackthepricesofamarket
basketmorelikeyoursandcompareyourCPIwiththenationalaverage.See
https://www.frbatlanta.org/research/inflationproject/mycpi.aspx
(https://www.frbatlanta.org/research/inflationproject/mycpi.aspx).
9 CentralIntelligenceAgency.TheWorldFactbook.UpdatedJuly15,2015

https://www.cia.gov/library/publications/theworldfactbook/geos/us.html
(https://www.cia.gov/library/publications/theworldfactbook/geos/us.html).
10 FRED,FederalReserveEconomicData,FederalReserveBankofSt.Louis.PersonalIncome

PerCapitahttps://research.stlouisfed.org/fred2/series/A792RC0A052NBEA
(https://research.stlouisfed.org/fred2/series/A792RC0A052NBEA).
11 Cangero,TheodoreDelorme,LukeF.andVlasenko,Polina.ImprovingtheEverydayPrice

Index.May16,2014https://www.aier.org/research/improvingeverydaypriceindex
(https://www.aier.org/research/improvingeverydaypriceindex).
12 Cangero,Theodore.PoultryandEggsLeadFoodPricesHigher.July17,2015

https://www.aier.org/research/poultryandeggsleadfoodpriceshigher
(https://www.aier.org/research/poultryandeggsleadfoodpriceshigher).

13

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13 U.S.BureauofLaborStatistics.Table1(20112012Weights).RelativeImportanceof

ComponentsintheConsumerPriceIndexes:U.S.CityAverage,December2014.
http://stats.bls.gov/cpi/cpiri_2014.pdf(http://stats.bls.gov/cpi/cpiri_2014.pdf).
14 Cangero,TheodoreandDelorme,LukeF.EPIMethodology.May15,2014

https://www.aier.org/research/epimethodology(https://www.aier.org/research/epi
methodology).

Glossary
Consumerpriceindex(CPI):Ameasureoftheaveragechangeovertimeinthepricespaid
byurbanconsumersforamarketbasketofconsumergoodsandservices.
Dualmandate:TheFederalReservesresponsibilitytousemonetarypolicytopromote
maximumemploymentandstableprices.
Inflation:Ageneral,sustainedupwardmovementofpricesforgoodsandservicesinan
economy.
Inflationrate:Thepercentageincreaseintheaveragepricelevelofgoodsandservicesovera
periodoftime.
Marketbasket:Aselectedgroupofconsumergoodsandserviceswhosepricesaretrackedfor
calculatingaconsumerpriceindexandmeasuringthecostofliving.
Pricestability:Alowandstablerateofinflationmaintainedoveranextendedperiodoftime.

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