Measuring inflation rate: Consumer Price Index CPI, GDP deflator & PPI
This video will teach you how to Measure Inflation using CPI & GDP Deflator, it will show you the difference between nominal and real interest rates, and the various costs of inflation.
The most well-known indicator of inflation is the Consumer Price Index (CPI), which measures the percentage change in the price of a basket of goods and services consumed by households.
consumer price index (CPI) A price index computed each month by the Bureau of Labor Statistics using a bundle that is meant to represent the “market basket” purchased monthly by the typical urban consumer.
The CPI market basket shows how a typical consumer divides his or her money among various goods and services.Most of a consumer’s money goes toward housing, transportation, and food and beverages.
The formula for calculating the Inflation Rate looks like this:
((CPI(f) – CPI(i)/CPI(i))*100
The method of calculating Inflation is the same, no matter what time period we desire. We just substitute a different value for the first one
negative inflation is called deflation.
“Disinflation” means that prices are not rising as fast as they once were
Producer Price Indexes (PPIs) Measures of prices that producers receive for products at all stages in the production process.
The Wholesale Price Index
The WPI is another popular measure of inflation, which measures and tracks the changes in the price of goods in the stages before the retail level. While WPI items vary from one country to other, they mostly include items at the producer or wholesale level.
The GDP Deflator is an index number that compares the nominal GDP to real GDP for a given year.
The nominal GDP of a given year is computed using that year's prices, while the real GDP of that year is computed using the base year's prices.
So nominal GDP is not adjusted for inflation while real GDP is the nominal GDP adjusted for inflation which reflects the real amount of goods and services produced within an economy
Unlike the CPI the GDP deflator is not based on a fixed basket of goods and services since it includes all domestically produced goods and services in a country. So Changes in consumer preference and the arrival of new goods/services in the market are also reflected in the GDP deflator
Costs associated with inflation are numerous:
1. Reduced international competitiveness
If a country has a relatively higher inflation rate than its trading partners, then its exports will become less competitive, leading to a fall in exports and a deterioration in the the country current account.
2. Confusion and uncertainty
When inflation is high, people are more uncertain about what to spend their money on. Also, when inflation is high, firms are usually less willing to invest – because they are uncertain about future prices, profits and costs. This uncertainty and confusion can lead to lower rates of economic growth over the long term
3. Boom and bust economic cycles
High inflationary growth is unsustainable and is usually followed by a recession. By keeping inflation low, it enables a long period of sustainable economic growth.
4. Menu costs
This is the cost of changing price lists. When inflation is high, prices need frequently changing which incurs a cost.
However, modern technology has helped to reduce this cost.
5. Shoe leather costs
Shoe leather cost refers to the cost of time and effort that people spend trying to counter-act the effects of inflation, such as holding less cash and having to make additional trips to the bank
6. Income redistribution
Inflation will typically make borrowers better off and lenders worse off.
Cost of reducing inflation
9. Falling real incomes
In periods of nominal wage restraint, even a small increase in inflation can lead to a fall in real wages.
High inflation is deemed unacceptable therefore governments / Central Bank feel it is best to reduce it. This will involve higher interest rates to reduce spending and investment.
Real vs. Nominal Interest Rates: An Overview
A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor. A nominal interest rate refers to the interest rate before taking inflation into account. Nominal can also refer to the advertised or stated interest rate on a loan.
real interest rate The difference between the interest rate on a loan and the inflation rate.
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