How the Consumer-Price Index Measures Inflation | WSJ

The video script discusses the significant rise in the US consumer price index (CPI) in 2022, marking its fastest increase in over 40 years. The CPI is a crucial economic indicator, reflecting the average household spending on a basket of goods and services. It influences decisions on tax brackets, Social Security, and food stamp benefits, and is closely monitored by the Federal Reserve. The Bureau of Labor Statistics (BLS) is responsible for selecting the basket's components and calculating the CPI, focusing on categories like food, transportation, and housing. The BLS employs over 450 workers to track the prices of up to 100,000 goods and services, ensuring the CPI's accuracy by comparing products to data points from the previous month. However, the CPI formula excludes non-direct spending and is based on an urban consumer's out-of-pocket expenses, which means it's an average that may not reflect individual experiences with inflation.

The script explains the process behind calculating the CPI, which involves the BLS assigning relative importance to each category based on consumer spending habits. The BLS's price checkers monitor price changes for a vast array of goods and services, as well as housing units, to ensure the CPI reflects current market conditions. The agency compares products to a detailed list from the previous month to ensure consistency in what is being priced. It's important to note that the CPI is based on an urban consumer's out-of-pocket expenses and does not include indirect spending such as nonprofit services, Medicare, Medicaid, or employer-sponsored healthcare plans. This highlights that the CPI is an average and may not accurately represent the financial situation of all individuals, as inflation can impact people differently based on their spending habits.

While the CPI is a closely watched indicator, the Federal Reserve prefers broader indexes like the Personal-Consumption Expenditures (PCE) Price Index. The script points out that the CPI updates its basket of goods every two years, whereas the PCE index adjusts its basket monthly based on current consumer trends. This difference in methodology means the PCE index can provide a more dynamic and timely reflection of inflation. The Federal Reserve uses both the CPI and PCE to get a comprehensive view of inflation's impact on the American economy. The script emphasizes the Fed's commitment to addressing high inflation and its mandate to promote maximum employment and stable prices for the American people.

The video script also addresses the behavioral changes that consumers undergo in response to sustained high inflation. It illustrates how inflation can lead to a cycle where individuals demand higher wages, businesses raise prices, and this in turn perpetuates further inflation. The script warns that if inflation remains high for an extended period, it can become embedded in the economy, leading to harmful effects. It suggests that by examining individual categories within the CPI, such as housing and food, consumers and economists can gain insights into whether inflation is broadening, which is a current concern for the economy. The CPI serves as a valuable tool for understanding if inflation is beginning to subside or if it is becoming more entrenched in economic activities.