BY KRISTIN HOVENCAMP
Any hopes of inflation subsiding were dashed when the August 2022 Consumer Price Index (CPI) report came in hotter than expected. The overall CPI rose to 8.3% from a year earlier. The Headline CPI tends to be a popularly referenced benchmark because it is usually the first inflation reading released each month. The CPI measures the average price change over time for a representative basket of consumer goods and services.
How do the markets use the CPI?
- As an economic indicator — As the most widely used measure of retail inflation, the CPI is a significant indicator of the effectiveness of public policy. The federal government uses the movement of the CPI to help formulate and monitor the effects of fiscal and monetary policies.
- As a tool for adjusting income payments — Social Security benefits and military and Federal Civil Service pension payments are indexed to the CPI. Many collective bargaining agreements tie automatic wage increases to the CPI. Some private firms and individuals use the index to keep rents, alimony and child support payments in line with changing prices. A commonly used acronym for cost-of-living adjustments is COLA.
- Determining tax bracket thresholds — Federal (and some state) income tax bracket thresholds and other parameters are adjusted to the CPI.
- Measured Items — Expenditure items in the CPI fall into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education, communication, and others. Housing, transportation, and food and beverages comprise the most significant categories in the CPI market basket.
What is the CPI missing?
In 2000, the Federal Reserve changed its preferred measure of inflation from the CPI to the chain-type price index for personal consumption expenditures (PCE). The Fed argued that the CPI is not an accurate cost-of-living index. For example, the CPI does not account for changes in consumer behavior, while the PCE accounts for the substitution of goods consumers make when prices rise or fall.
The Fed will continue to watch the CPI, PCE, and other inflation measures to gauge the economy’s health. Consumers best use the CPI to help identify times of inflation based on the short-term increase or decrease of goods and services.
Kristin Hovencamp is an Investment Executive and Director of Business Development with HAZLETT WEALTH MANAGEMENT, LLC, which is independent of Raymond James and is not a registered broker/dealer. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. 675 Sun Valley Road, Suite J1 + J2 Ketchum, Idaho 83340 208.726.0605.