How is inflation measured? It's a good question, considering prices for all goods and services do not increase at the same rate and the same time. This is the challenge faced by economists as they try to describe what is happening to the economy and consumer purchasing power.
Inflation is measured through two indexes, each of which represents of a group of prices. One index measures how pricing is affecting consumers, or buyers. The other index measures how pricing is affecting producers, or suppliers and vendors. The two indexes are as follows:
CPI: Consumer Price Index
The CPI is the index that measures prices that are of concern to consumers. This index is made up of thousands of specifically selected prices of goods and services. Economists labored to select the right goods and services to be included in these numbers. Each month the US Bureau of Labor Statistics collects information on prices from thousands of companies, and these numbers are combined to create the index for that month. This number represents how inflation is affecting consumers.
PPI: Producer Price Index
The PPI is the index that measures the selling prices that matter to producers, or companies, vendors and suppliers. This index, which is also compiled by the US Bureau of Labor Statistics, is comprised of thousands of prices and is measured monthly.
What The CPI And PPI Tell Us
These two indexes tell us how consumer purchasing power is doing in times of economic booms and economic recession. It lets the government know if consumers and producers are surviving the ups and downs of the market.
Interest Rates And Inflation: The Connection
The Federal Reserve takes the CPI and PPI numbers quite seriously. If inflation is high and unemployment is also high, the Fed may lower interest rates to increase liquidity and to encourage lending. If the CPI and PPI are rising at a slow, steady rate and unemployment is low, the Fed may keep interest rates the same. If the CPI and PPI are rising too quickly, indicating hyperinflation, the Fed may increase interest rates so lending is costlier. This would be an attempt to slow economic growth and inflation. While the CPI and PPI are not the only factors considered when the Fed changes interest rates, these are significant factors in those kinds of decisions.
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