Inflation metrics business leaders should follow
Business owners have two concerns about inflation: their own selling prices and costs, and the general inflation trend. The general trend is important information in trading strategy and also helps managers understand the direction in which their particular prices are heading.
A guide to data sources for company-specific inflation measures appears below. First comes an explanation of common measures of inflation and how business leaders should use them.
The consumer price index attracts the most attention, as well as the most criticism. It’s useful as long as it’s not taken too seriously. Many people express the belief in casual conversation that actual inflation exceeds the increase in the CPI. There is a bit of truth mixed in with an error. The truth is that the CPI derives from a “shopping cart” typical of urban consumers. The basket includes not only groceries, but all kinds of goods and services. In the details of the CPI, you will find tuition fees, the cost of accommodation and travel as well as gasoline and food. But the proportions of this basket do not reflect the expenses of each. Some people spend more on travel and less on cable TV. Vegetarians don’t buy a lot of meat even though it is in the CPI. It is likely that no one’s spending will match the CPI basket proportions.
Yet the CPI actually represents the average. People tend to focus on price tags they see regularly, such as gas or milk. The thousands of other prices they pay receive far less attention.
Economists believe that the CPI tends to overestimate inflation, contrary to what many people think. The core concern of economists is the weight given to different components and how people react to price changes. Here is an example. Suppose the price of beef and chicken have been relatively stable, but something is happening at the feedlots that drives up the price of beef, without affecting chicken prices. Consumers will respond to higher beef prices by consuming less beef and replacing chicken and other meats. What weight should beef have in the overall index after this change in behavior?
The CPI keeps the same weights for two years and then updates them. Another important measure, the Personal Consumption Expenditure Price Index, continually adjusts the weights. Economists prefer this approach, which shows a lower rate of inflation.
These two measures of inflation are calculated with and without food and energy. The exclusion of food and energy in some indices seems wrong because we all buy food and energy. The logic of the exclusion, however, is that they vary differently from other prices. Gasoline prices rise and fall with oil prices, but the CPI almost always rises. Thus, gas does not always indicate inflationary pressure in the economy. Similarly, a bad harvest year can drive up food prices, but this is unlikely to persist.
The metric we are looking at is not very important to the trend over time. At the time of writing, all inflation indices are rising much faster than they were a few years ago. They all tell the same story. The Federal Reserve is focusing on the personal consumption expenditure price index excluding food and energy, so it’s a good index for business leaders to watch, but the CPI is showing a similar acceleration, but offset by a higher average. Historical data is available in the FRED database.
Businesses should also watch for inflation in their selling prices and costs. Detailed components of the Consumer Price Index are available from the Bureau of Labor Statistics, as are detailed components of the Consumer Price Index. Producer price index. Some industry associations and companies provide data specific to their specialties.
Labor costs are also important for most businesses. Headline labor inflation is best measured with the Employment cost index. Average hourly earnings are more widely reported, but this measure changes with the composition of the labor force. For example, during the containment phase of the pandemic, many low-wage employees lost their jobs. The average then reflected only the highest earners, suggesting an acceleration in wages that was not happening. The employment cost index avoids this problem by looking at wage changes for the same job. The ECI also measures benefits, which may increase more or less than wages.
Economists prefer the economy to have low and constant inflation. One reason is that high and variable inflation forces business leaders to devote valuable time and attention to inflation. It’s needed now, but it’s a loss of productivity for some of the most important workers in the economy.