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CPI Concerns

Jan 25, 2011 • 314 Views

Should we care if China has a 5.1% annual inflation rate?  A little.

The International Herald Tribune tells us that just 1/4 to 2/5 of the price we pay in the U.S. for an imported item reflects the cost of the good. Other slices of the price pie such as transportation, wages and salaries, profit, and electricity bills have more of an impact.

Instead, it is the Chinese citizen that will suffer. One Chinese official said, “4 percent, China can bear it-beyond 5 percent, people will complain a lot.” And, according to this journalist, because the Chinese use an outdated list of goods and services, the actual rate could even be twice as high.

But then, many people challenge the contents of the market basket on which we base our inflation statistics. With 8 categories of goods and services (food and beverages, housing, apparel, transportation, medical care, recreation, education & communication, other goods & services), the CPI might not be changing fast enough to reflect changes in spending. Here, we talked about the Billion Prices Project as an alternative.

The Economic Lesson

For the U.S. Consumer Price index (CPI) monthly, we not only hear an inflation rate but also the core rate that excludes food and energy. Some economists believe that the most accurate way to track inflation is through that “core” inflation rate. Why? Because a basic goal of inflation statistics is to convey price trends. By eliminating food and energy which tend to be more volatile than the other 6 categories of the CPI, the actual trajectory of prices might be more accurately displayed. To see trends firsthand, you might want to look here for a history of inflation rates in different countries until 2009.

Using the rule of 70 (70 divided by the percent change), 5.1% Chinese inflation means that prices will double every 14 years. Looking at recent US inflation, $1987.70 in 2010 had the same purchasing power as $1000 in 1986 according to a Federal Reserve bank of Cleveland Inflation Calculator.

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