The Fed focuses on the rate of growth in inflation more than any other variable when it sets interest rates. If it senses inflation is rising—or that the public expects inflation to rise—they’ll raise the cost of borrowing to keep it in check. And this, in turn, impacts the housing market, the stock market, and ultimately all of us.
The best-known official measure of inflation is the Consumer Price Index for all Urban Consumers, or CPI-U. The CPI-U is compiled by the Bureau of Labor Statistics (BLS), with help from the U.S. Census Bureau, and released each month. Basically, the Census Bureau surveys a sample of the population asked to keep spending diaries. BLS then creates a price index for 211 basic goods and services categories for 38 regions in the country. It weights the categories according to their proportion of spending within the consumer budget, and averages all the indices to get a national average. Given the nature of how the CPI is put together, it’s bound to provide a different picture of price movements than many people experience. For one thing, regional price levels vary widely. Between 1997 and 2007, Chicago’s regional CPI rose 24.3 percent while San Franciscans saw prices jump over 35 percent.
And because the degree to which various products and services are weighted in the index depends on average spending patterns, folks whose spending differs significantly from the average will experience a different rate of inflation. For 2005, for instance, spending on “gasoline and motor oil” accounted for 4.3 percent of average expenditures. But for those that drove considerably more than the average person, rising gasoline prices contributed considerably more to their cost of living.
Compared to decades past, inflation has been fairly benign these days. Given the impact high inflation can have on our savings and quality of life, let’s hope it stays that way.