Episode 6
Episode summary
Inflation and the consumer price index (CPI) have been on everyone’s mind for the last couple of years. In this episode, Liz tackles the hottest topic in economics, how it makes us feel, and why we should care about it for more than its impact on our wallets.
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Transcript
Liz Wilke (00:00:00) – Hi, I’m Liz Wilke, and this is the Gustonomics Podcast. Each week, I bring you about 10 minutes of economics knowledge so you can be more informed, use the information in your business or work, or maybe just feel more with it. Whatever brings you here, thanks for checking out the podcast. This week, it’s all about inflation. Why is inflation such a hot topic right now? Honestly, not right now, but in recent memory. We haven’t cared this much about inflation since the 1970s, but it’s on everybody’s lips these days.
Liz Wilke (00:00:36) – Inflation is the reason Jerome Powell is a household name these days, and why mortgage rates are now 7% instead of 2021’s 3%. Well, inflation went bananas in 2022, and it’s eating away at Americans’ wallets. Inflation is really just a term for the idea that money doesn’t go as far as it used to. If you’ve ever heard someone complain that things that used to cost a nickel now cost a dollar, you already know a thing or two about inflation.
Liz Wilke (00:01:08) – So while that’s the idea, in practice, we need an actual number to work with, a way to measure how the value of a dollar is changing. And no surprise, there are many ways to measure it. So I’m mostly going to be talking about one way to measure it, and referencing the many variations of that one way that people like to use. Maybe we’ll get into that in a later episode. But enter the Consumer Price Index, aka the CPI, which is the number most mentioned when the news reports inflation.
Liz Wilke (00:01:41) – The Consumer Price Index is a really high-level indicator that gives a single number to tell the government, investors, and economists like me what is going on at a 30,000-foot view with the price of things. This one number represents the buying experience faced by hundreds of millions of people buying thousands of different things, in dozens of different ways, across all 50 states and the District of Columbia. So how do you even calculate that number?
Liz Wilke (00:02:16) – Okay, it’s more complicated than what I’m about to say, but basically, the U.S. Bureau of Labor Statistics starts by asking tens of thousands of people living in America about everything they spend money on, from cheese to phones to gym services and toys, and then they tally it all up. And that gives them a list of things and services that Americans spend money on, and also how much of their budget each good or service represents. So on this list, at least, for instance, toothpaste counts for a little, and housing counts for a lot.
Liz Wilke (00:02:54) – So once they have that list, then the BLS sends people to the store. Literally, live people trained and paid to do this go to specific physical or online stores where all these things can be bought and are chosen randomly across the country. So these people check the price of each item they’re supposed to check, and then they send that information back to the Bureau every one to two months on a rolling basis. Okay, again here, this is also proportional to the U.S. population.
Liz Wilke (00:03:28) – So New York City prices count for more than Helena, Montana prices, because more people face New York City prices than Helena prices. And also, technically, it’s only places with a high enough population, about 2,500. So the CPI doesn’t include prices that the good folks in places like Slade, Kentucky face. Still, even with that limitation, the CPI covers about 90% of the American population.
Liz Wilke (00:03:57) – In the end, you get a single number that is the result of many, many items being priced out over many, many areas and with many, many numerical adjustments to end up with a single number, which is an estimate of how much more or less expensive this theoretical list of things is than before. It can be a year before, a month before, 10 years before. It all depends on how you want to compare. Side note, if this seems like a lot of sausage making to you, I don’t blame you.
Liz Wilke (00:04:31) – It’s a mismatch of averages, and the end result doesn’t really explain what the situation looks like for any particular person. And that’s fine, because most people don’t need to know the CPI on a regular basis. They just go to the grocery store and see that food is more expensive, for instance. And the government also knows that the CPI isn’t really telling the story about any typical American, but for the purposes of making policies and moving money around an entire economy, it is, as I like to say, ultra mega good enough.
Liz Wilke (00:05:07) – Now, if you’re curious, there are plenty of websites that will calculate your personal inflation rate based on what you spend money on. These sites ask you about your spending habits in order to calculate a measure of how much prices are changing for the specific things that you buy. It’s really fun to compare, so we’ll put some in the show notes for you to try out, but do take note. One gave me a rate of 4.3% for my personal inflation rate, and another gave me a rate of 8.8% for the same month. So there’s really a lot of variation here.
Liz Wilke (00:05:38) – I would be wary about taking them too seriously.
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Liz Wilke (00:06:16) – Welcome back. I’m talking about inflation and the Consumer Price Index, or CPI. If you’re still wondering why you should care about inflation at all, really, you should care about inflation not because you care about dollars, but about what your dollars can buy. Groceries. Housing. Childcare. Clothing. Gas. Movies out. If inflation is going up faster than your income is, your standard of living is going down because you can buy fewer of all those things.
Liz Wilke (00:06:47) – Of course, there are many valuable things that money can’t buy, like love and friendship, that definitely affect your standard of living. But you’re on your own to find those things, listener. We’re just talking about the money stuff today. And before the break, I effectively said that the CPI isn’t reflective of any single person’s experience and any thinking person can easily see if their bills are going up without the help of a government indicator. So you might be thinking by now, I know the price of eggs, gas, and electricity for my home.
Liz Wilke (00:07:21) – Why should I care about the Consumer Price Index? First reason. You should care about the CPI if you’re the beneficiary of a government program or service, or you love someone who is. Social security payments, for example, are tied to the CPI. So when the CPI goes up, so do social security payments. But you can get bitten by inflation well before social security payments change, since that only happens once a year. It’s one of the reasons why last year’s inflation was so hard on people with fixed incomes.
Liz Wilke (00:07:52) – Their benefits were getting eaten away by inflation without the adjustment. Second reason. If you employ people, you might be feeling pressure to increase their pay. And it’s not just because the talent market is still tight. When workers feel their incomes go down because stuff is more expensive, they try to negotiate for bigger increases in pay to offset that. One way businesses have been getting around this is by offering larger bonuses to show appreciation without committing to long-term pay increases.
Liz Wilke (00:08:22) – But that strategy only goes so far if inflation continues for a long time. Third reason. You should care about CPI. If you have an adjustable rate loan or want a new loan. The Fed keeps a laser-beam focus on the CPI to know when to raise and cut rates. As long as the CPI remains high, the Fed will keep interest rates high to slow down the economy. When it’s been falling for a while and getting near the Fed’s long-term goal, 2% give or take, interest rates will come down. Another side note here.
Liz Wilke (00:08:55) – The Fed actually tracks more than one CPI. You can slice and dice the number to look at food, or housing, or energy, or anything you want. We’ll probably cover the many shades of CPI in another episode. But as long as the main one is high, expect higher interest rates. Or savings rates, in case you have some extra cash. And earning some cash on that sounds interesting to you. Whatever you think about the CPI, just know that the CPI and the unemployment rate are the two most important indicators in the economy right now driving policy.
Liz Wilke (00:09:29) – And maybe that’s enough reason to care. That’s it for this week’s episode. I hope you learned something new and useful for yourself and your business. Please let us know what you think about the podcast by leaving a review. Or share it with a friend or colleague who might enjoy it. I’m Liz Wilkie, thanks for listening, and I’ll CPI you later.
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