Consumer Price Index
The Consumer Price Index (CPI) tracks the cost of a fixed set of
goods that are considered representative of a typical consumer’s
purchasing actions by comparing current prices with prices from an
earlier period.
Mathematically, it represents changes in prices of
all goods and services purchased by an average household for
consumption. Costs of living and sales and excise taxes paid by the
consumer are included in the measure; however, investment tools -
stocks and bonds - and income taxes are not. Proliferate use of this
measure of inflation is attributed to the fact that all of the
factors of production that determine the inflationary forces from
both the supply and demand side are considered.
In the United States, the report itself is broken down into multiple
aggregate groups, allowing industry dissection with greater
convenience. The CPI's are available by:
- Location - for the four Census regions of the US, city
classifications of various sizes and classes, and down to 26
local area classifications.
- Category - namely Energy, Food, and Core (Goods and
Services).
- Population Group - the CPI for All Urban Consumers (CPI-U)
and the CPI for Urban Wage Earners (CPI-W). The CPI-U takes into
account 87% of the population, including professionals, the
self-employed, and the unemployed. The CPI-W at 32% converts
only hourly wage earners and clerical workers.
Prices for the CPI are collected from a gamut of urban areas,
stores, and service establishments and items are weighted according
to expenditures on that item as reported by the Consumer Expenditure
Survey. Changes in the price level, expressed in percentage terms,
are weighted appropriately.
As the CPI is extremely diversified, it is difficult to see consequential
movements given the "noise" created by volatile factors
like energy and food prices. Keeping your attention to the
"core rate" is recommended - this eliminates much noise.
In the United States, the average increase in CPi is about 1 to 2%;
if the increase if more dramatic than this it is a warning of plummeting
purchasing power and possible inflation.
Fundamental Analysis of the CPI
The value of the CPI in fundamental analysis rest heavily on its
reliability as an indicator of inflation - it is often used as a
deflator to find the purchasing power of a currency. The information it provides
with regard to price changes is utilized by consumers as in aid to
making economics decisions, and by governments as a guide for
structuring and implementing fiscal and monetary policies. In
particular, national banks tend to see a rising CPI as a harbinger
of high inflation, which they battle by raising short term interest
rates. As such:
When
prices increase and the CPI is therefore high, the purchasing power of a currency declines
and there may be an increase in interest rate.
When prices decrease and the CPI is low, purchasing power
increases.
Using the
CPI, one can predict future interest fluctuations and the resulting changes in currency exchange rates. Changes
in interest rate are a trigger for trading techniques like
carry-trades. For more information, check Strategies.
When used in conjunction with a report on a nation's exports,
the CPI is useful in checking on the country's position in
international trade. Along with basic knowledge of the economic
condition of a given country, the CPI will help in answering the
question of whether the country making or losing money on its products
and services:
When the CPI is high, exports are expected to be on the
rise.
When the CPI drops, exports will fall and imports are
expected to take the spotlight.
For example, Japan has a massively export-oriented economy. When
Japan's CPI began to fall and the yen started rising, the government
was in a panic trying to lower the value of the yen in order to keep
its exports high. Relative economic health can be determined using
these two indicators.
As a side note, it is extremely useful to keep track of a
country's exports regardless; it is a highly observed indicator.
Prices of exports often change relative to a currency's strength.
For more information concerning the report published in the United
States, or to obtain it, visit the U.S. Department of Labor webpage.
A comparable report can be downloaded from the European Central
Bank, which publishes its monthly bulletin regarding the HICP (the
EU’s CPI equivalent) and other economic indicators.
The CPI is released by the Bureau of Labor Statistics at 8:30 am EST
on the 15th or each month, several days after the Producer Price Index’s
(PPI)
release.
