Consumer Price Index (CPI)

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The following perspective is excerpted from a speech given by Federal Reserve Chairman Ben S. Bernanke at the Fourth Economic Summit at the Stanford Institute for Economic Policy, Palo Alto, CA on March 2, 2007. In it he looks at the effect of foreign economies on the price levels here in the United States:

“…What, then, is the evidence for the view that globalization is affecting the inflation process in the United States? Of the various channels that have been suggested, probably the most intuitive is the idea that greater openness to trade has increased the influence of import prices on domestic inflation. In the major industrial economies over the past decade or so, import prices--particularly the prices of imported manufactured goods--have generally risen at a slower rate than other consumer prices, slowing overall inflation. The slower growth in import prices reflects to some extent rapid productivity gains in the production of manufactures, an important component of trade. Increased exports by low-cost emerging-market economies have also helped keep down the prices of imports received by the United States and other industrialized countries. Indeed, the share of U.S. non-oil imports coming from the emerging Asian economies has increased from 27 percent to 34 percent over the past decade or so.

“Overall, research indicates that trade with developing economies in particular has slowed the rate of growth of import prices faced by industrialized countries, with estimates of the reduction ranging widely from 1/2 to 2 percentage points. …. Typical estimates of the short-term effect on the overall inflation rate of less-rapid increases in the prices of imports stemming from trade with China are in the neighborhood of 0.1 percent or less per year—a discernable but certainly not a large effect.

“On the other hand, not all aspects of globalization and trade reduce inflation. For example, globalization has been associated with strong growth in some large emerging-market economies, notably China and India, and this growth likely has contributed to recent increases in the prices of energy and other commodities. During 2003-05, for example, China alone accounted for nearly one-third of the growth in both global real gross domestic product (GDP) and oil consumption. It is difficult to assess the exact extent to which increased demand by developing countries has contributed to the run-ups in commodity prices in recent years, as these prices are also affected by supply conditions and other factors. However, one study estimated that, if the share of world trade and world GDP enjoyed by non-industrial countries had remained at its 2000 levels, then by 2005 real oil prices would have been as much as 40 percent lower, and real metals prices 10 percent lower, than they actually were (Pain, Koske, and Sollie, 2006). Accordingly, in the past several years, the effect of growth in developing economies on commodity prices has been a source of upward pressure on inflation in the United States and other industrial economies.

“When the offsetting effects of globalization on the prices of manufactured imports and on energy and commodity prices are considered together, there seems to be little basis for concluding that globalization overall has significantly reduced inflation in the United States in recent years; indeed, the opposite may be true. That said, the integration of rapidly industrializing economies into the global trading system clearly has had important effects on the prices of both manufactures and commodities, reinforcing the need to monitor international influences on the inflation process.”

http://www.federalreserve.gov/boarddocs/speeches/2007/20070302/default.htm

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The following is excerpted from a speech given by Federal Reserve Vice Chairman Donald L. Kohn at the European Economics and Financial Centre Seminar at the House of Commons in London, England on July 6, 2006. In it he discusses how inflation in the United States is affected by the forces of globalization:

“Although inflation is ultimately a monetary phenomenon, it is important to stress the word ‘ultimately’ in that formulation. The long run in which monetary policy exerts its influence on nominal magnitudes is the summation of individual short runs in which pressures in labor and product markets help to shape price dynamics. In the world in which we live, it seems natural to expect, as others have argued, that the greater integration of product and financial markets would have exerted some downward pressure on inflation. I cannot look back at the experience in the United States over the past decade without discerning the imprint of such forces. The opening up of China and India, in particular, represents a potentially huge increase in the global supply of mainly lower-skilled workers. And it is clear that the low cost of production in these and other emerging economies has led to a geographic shift in production toward them; from a U.S. perspective, the ratio of imported goods to domestically produced goods has risen noticeably in recent years.

“However, the extent of the disinflationary forces let loose by this shift in the pace of globalization is less obvious. The United States is more open, but it is also large in size and scope. Many U.S. goods and most services are still produced domestically with little competition from abroad. In addition, the significant expansion of production in China and elsewhere has put substantial upward pressure on the prices of oil and other commodities, many of which are imported for use as inputs to production in the United States. While we can point to types of goods for which prices are restrained by forces from abroad, the net effects of globalization on domestic inflation of all goods and services need not even be negative, especially in today’s environment of strong global growth.

“… [T]he existing research does highlight several channels through which globalization might have helped to hold down domestic inflation in recent years. These channels include the direct and indirect effects on domestic inflation of lower import prices, a heightened sensitivity of domestic inflation to foreign demand conditions and perhaps less sensitivity to domestic demand conditions, downward pressure on domestic wage growth, and upward pressure on domestic productivity growth.

“Let me summarize the empirical evidence from work on U.S. inflation my colleagues and I have done at the Federal Reserve Board, as well as from our readings of other studies. In the United States, the increase in core import prices since the mid-1990s has averaged about 1-1/2 percentage points less per year than the increase in core consumer prices. According to our model, the direct and indirect effects of this decline in the relative price of imports held down core inflation by between 1/2 and 1 percentage point per year over this period, an estimated effect that is substantially larger than it would have been in earlier decades. However, much of the decline in import prices during this period was probably driven by the appreciation of the dollar in the late 1990s and the effects of technological change on goods prices rather than by the growing integration of world markets. In addition, import prices have risen at least as rapidly as core consumer prices over the past several years and thus no longer appear to be acting as a significant restraint on inflation in the United States.”

http://www.federalreserve.gov/boarddocs/speeches/2006/20060706/default.htm

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The following is excerpted from a speech given by Federal Reserve Governor Susan Schmidt Bies to the Tech Council of Maryland’s Financial Executive Forum in Bethesda, MD on January 18, 2006. In it she discusses current trends in consumer prices and factors that may influence the Consumer Price Index in the near future:

“…Turning to prices, core inflation has stayed relatively low in recent months despite the run-up in energy costs. For example, the twelve-month change in the price index for personal consumption expenditures excluding food and energy, a widely watched indicator of core inflation, moved down from 2.3 percent in November 2004 to 1.8 percent in November 2005.

“Although energy prices have receded from the highs last fall, crude oil costs are still well above year-earlier levels…. Higher energy prices have also affected businesses, particularly in those industries with energy-intensive production processes and those that purchase a large share of energy-intensive products, such as industrial chemicals and plastics. There is only limited evidence, most of it anecdotal, of pass-through to consumer prices from the run-up in energy prices. However, we are seeing the effects in the price data for certain energy-intensive categories, such as transportation.

Futures markets currently expect only limited increases in the price of crude oil this year. Nevertheless, tight resource utilization is likely to put pressure on prices…. As in the mid- to late-1990s, resilient productivity growth appears to be helping contain the inflationary pressures that might otherwise be expected to accompany a narrowing margin of resource slack. That said, we at the Federal Reserve will remain vigilant for any sign of a deterioration in the inflation outlook.”

http://www.federalreserve.gov/boarddocs/speeches/2006/20060118/default.htm

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The following is excerpted from a Frequently Asked Questions page of the Bureau Of Labor Statistics website. It details the procedure of how the Consumer Price Index is determined:

"How are CPI prices collected and reviewed?

Each month, BLS data collectors called economic assistants visit or call thousands of retail stores, service establishments, rental units, and doctors' offices, all over the United States to obtain information on the prices of the thousands of items used to track and measure price changes in the CPI. These economic assistants record the prices of about 80,000 items each month representing a scientifically selected sample of the prices paid by consumers for the goods and services purchased.

During each call or visit, the economic assistant collects price data on a specific good or service that was precisely defined during an earlier visit. If the selected item is available, the economic assistant records its price. If the selected item is no longer available, or if there have been changes in the quality or quantity (for example, eggs sold in packages of 8 when they previously had been sold by the dozen) of the good or service since the last time prices had been collected, the economic assistant selects a new item or records the quality change in the current item.

The recorded information is sent to the national office of BLS where commodity specialists who have detailed knowledge about the particular goods or services priced review the data. These specialists check the data for accuracy and consistency and make any necessary corrections or adjustments which can range from an adjustment for a change in the size or quantity of a packaged item to more complex adjustments based upon statistical analysis of the value of an item's features or quality. Thus, the commodity specialists strive to prevent changes in the quality of items from affecting the CPI's measurement of price change. "

http://stats.bls.gov/cpi/cpifaq.htm#Question_9

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This is excerpted from an interview done with economist James Tobin that was published in The Region, a publication of the Federal Reserve Bank of Minneapolis. It appeared in December 1996.

REGION: "In an essay on monetary policy in Fortune's Encyclopedia of Economics you ask the question, "Should policymakers give priority to price stability or to full employment?" What is your response to that question?"

TOBIN: "My response is that they should pay attention to both of those objectives. They certainly should, in my opinion, take a pragmatic view of the combination of those goals. I think the current Federal Reserve has done that, under both Volcker and Greenspan. Their main objectives for monetary policy have been overall macroeconomic performance, and that includes the reduction of unemployment as much as that can be done, and also controlling inflation. I think they've done a good job. I think they look at unemployment numbers as one guide to policy, and inflation numbers as another guide to policy. They don't say, "We're just going to look at one." Likewise, they don't make monetary policy in terms of some intermediate monetary aggregates; that was very popular in the '70s, until Paul Volcker abandoned the monetary aggregates in 1983.

"We have the best record since the 1980s of any G-7 country in terms of macroeconomic policy, and I think that comes from not saying we are for price stability only; rather, it comes from saying we care about what happens to the real economy. As I said, I think the Fed has done very well recently, and I've not been a routine fan of the Fed during my career. Maybe they can continue to get lower rates of unemployment without getting any worse inflation than we're having now. It's quite possible that the inflation-safe unemployment rate is even lower than what we have now. People who had estimated it at 6 percent have since changed their minds; maybe they will again."