Inflation: definition

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Flag of the United States.svg.png This article contains details specific to United States (US) investors. It may not apply to non-US investors.

Inflation is defined by one ordinary English dictionary as

a. A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money.
b. The rate at which this increase occurs, expressed as a percentage over a period of time, usually a year.

— American Heritage Dictionary[1]

The U.S. Bureau of Labor Statistics says that

Inflation can be defined as the overall general upward price movement of goods and services in an economy.

— Bureau of Labor Statistics[2]

One textbook says:

Inflation is an increase in the overall price level that results in a decline in the value or purchasing power of money.

— Economic Principles: A Business Perspective[3]

In the United States, one common measure of consumer prices is CPI-U (the Consumer Price Index for All Urban Consumers), and the measure of annual inflation is thus the annual percentage increase in CPI-U. For example, the Treasury product called "Treasury Inflation Protected Securities" (TIPS) uses the word "inflation" to refer to principal and interest payments which are linked to CPI-U.

You can avoid unproductive argument by recognizing these as widely understood meanings. If you prefer something different, you can add clarity by using a narrower term than "inflation"--for example, "currency inflation"--and by defining how you use the term the first time you use it.

The CPI indexes of the U.S. Bureau of Labor Statistics

Within the United States consumer price levels are measured by a family of statistical indices provided by the U.S. Bureau of Labor Statistics (BLS), with designations beginning "CPI" for "Consumer Price Index." The most common of them is often referred to as "the" CPI, but more accurately is referred to as CPI-U, Consumer Price Index for All Urban Consumers. This index is used by the Treasury to adjust TIPS and series I savings bonds, and is the index commonly used by economists when calculating "real" returns.

Because different groups have different patterns of expenditures, the BLS maintains other CPI indices. Social Security cost-of-living indexes are linked to CPI-W, Consumer Price Index for Urban Wage Earners and Clerical Workers. Advocates for the elderly such as the American Association of Retired People (AARP) have lobbied for the adoption of an index, CPI-E, which more accurately reflects spending patterns of the elderly. Of late, various economists have suggested that CPI-U overstates inflation and have proposed the adoption of a new methodology, the "chained" CPI, such as C-CPI-U.

Core inflation, and measurements used by the U.S. Federal Reserve in setting monetary policy

Inflation as defined above can also be called total inflation. For the limited and specific purpose of setting monetary policy, the Federal Reserve uses, not total inflation, but core inflation. Core inflation excludes the prices of food and energy. It formerly used Core CPI, a variant of CPI-U. It nows uses variants of the Personal Consumption Expenditures Price Indexes (PCE), which are provided, not by the BLS, but by the U.S. Bureau of Economic Analysis (BEA).[4][note 1] Core inflation ignores food and energy in order to provide a measure that does not include volatile and transient components. However, core inflation measures have never been used as the measure of inflation in Treasury Inflation Protected Securities (TIPS), nor to adjust Social Security benefits.

Currency "inflation"

During the period of time from about the mid-1800s to the mid-1900s when many major currencies were on the gold standard, the word "inflation" referred not to price, but to currency, and meant an increase in the amount of currency relative to the amount of precious metal backing it. An example would be the US Gold Reserve Act of 1934, which increased the price of gold from $20.67 to $35, i.e. allowed the same amount of gold to back more dollars. The result was that there was currency inflation at the same time as (price) deflation. Conversely, from 1916 through 1920, the CPI roughly doubled while the price of gold remained fixed at $20.67, so there was severe price inflation in the absence of any currency inflation.

Resources

  • The Federal Reserve Bank of Cleveland has a paper On the Origin and Evolution of the word Inflation
  • MeasuringWorth.com offers a variety of long-term statistical series, such as the official British price of gold from 1257 through 1945.
  • Monthly values of CPI-U from 1913 to date can be obtained, in a direct spreadsheet-readable .CSV format, by using the US Bureau of Labor Statistics' Series Report tool: Series ID CUUR0000SA0, Table Format, All Years, Text, Comma delimited, Include Annual Averages.

Notes

  1. Specifically, it now uses "PCE-excluding food and energy" and "trimmed PCE."

References

  1. "Inflation, American Heritage Dictionary".
  2. "Overview of BLS Statistics on Inflation and Prices".
  3. Rubb, Stephen; Sumner, Scott (2019). Economic Principles: A Business Perspective.
  4. "Comparing Two Measures of Core Inflation: PCE Excluding Food & Energy vs. the Trimmed Mean PCE Index".

External links