Inflation refers to the general increase in prices of goods and services over time. It is an important economic concept that affects all aspects of our daily lives, from the cost of groceries to the price of gas. As such, measuring inflation is crucial for understanding the overall health of the economy and for making informed policy decisions.
There are several different measures of inflation, each with its own strengths and weaknesses. The two most commonly used measures of inflation are the Consumer Price Index (CPI) and the Producer Price Index (PPI).
Consumer Price Index
The CPI is a measure of the average change over time in the prices paid by urban consumers for a basket of consumer goods and services. This covers a wide range of products, including food, housing, transportation, and medical care. The CPI is often used as a measure of inflation for individuals because it reflects the prices that consumers actually pay for goods and services.
Producer Price Index
In contrast, the PPI measures the average change over time in the prices received by domestic producers for their goods and services. It covers a wide range of industries, including manufacturing, mining, and agriculture. The PPI is often used as a leading indicator of inflation, as changes in producer prices can eventually lead to changes in consumer prices.
Limitations of CPI and PPI
While both the CPI and the PPI are important inflation gauges, they have some limitations. For example, the CPI does not take into account changes in consumer behavior, such as the substitution effect, which occurs when consumers switch to cheaper products when prices rise. This means that the CPI may overstate the true rate of inflation. Additionally, the CPI does not include changes in the quality of goods and services which can also affect prices.
The PPI also has limitations, as it only measures prices at the producer level and does not reflect the prices paid by consumers. Additionally, the PPI may be influenced by changes in input prices, such as the cost of raw materials, which can vary independently of consumer demand.
Personal Consumption Expenditures Price Index
Another measure of inflation is the Personal Consumption Expenditures Price Index (PCE). This index is similar to the CPI but takes into account changes in consumer behavior and the quality of goods and services.
Billion Prices Project
A newer measure of inflation is the Billion Prices Project (BPP), which uses data from online retailers to track changes in prices in real-time. The BPP is able to capture changes in prices more quickly than traditional measures of inflation and can be a useful tool for monitoring inflation in real-time.
Measures of core inflation
In addition to these measures of inflation, there are also measures of core inflation, which exclude volatile items like food and energy. This is done to get a better sense of the underlying trend in inflation, as food and energy prices can be influenced by factors outside of the control of monetary policy.
Why is inflation relevant to investors?
Inflation can influence the valuations of assets in the markets. High inflation can be quite detrimental to many types of assets, such as technology stocks. On the other hand, there are certain types of assets in the right context that are more resistant to inflationary devaluation. Our team here at Waller and Wax can help you make the right adjustments to your portfolio in the face of changing inflationary environments.