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It delves into how the rate of inflation relates to the CPI and what tools
the government uses to predict inflation. Moreover, it explores what happens
when the government incorrectly predicts the rate of inflation. The U.S.
government watches the CPI as a way to determine how fast the rate of inflation
is growing. The CPI is a good measurement simply because it is an index of all
the goods and services used by consumers in households, and is calculated on a
monthly basis. The goods and services that are actually looked at come from a
survey of the past couple of years. Usually economists look at the core rate of
the CPI, which excluded food and energy prices, since they fluctuate so rapidly.
The article points out some examples where the corn produced in the United
States could be directly affected by the weather. Also the recent oil price
increases is directly related to OPEC and their choice to cut back on the
production of oil. However the CPI is not a perfect measurement as Alan
Greenspan, chairman of the Federal Reserve, has acknowledged. It usually
overestimates the rate of inflation because the goods looked at are from
previous years and do not include the addition of new products into the market.
One example of this was the increase in cellular phones over in the 1990's. The
Bureau of Labor Statistics was not including them in the price index simply
because they didn't seem to fit into one particular category. So how does the
CPI relate to some of the current events in the U.S. economy? Kathleen Madigan
writes about last April when the CPI was overestimated by analysts.
When the CPI jumps sharply it suggests that rate of
inflation is increasing. In April of 1999 the CPI jumped a sharp 0.7 percent
suggesting that inflation was on the rise. At the same time market analysts
anticipated that the Federal Reserve was going to increase the interest rates at
the beginning of May. Because of this combination, the Dow Jones industrial
average tumbled almost 200 points. If some one who borrows money in terms of
something such as a home mortgage loan suddenly encounters unexpectedly high
increase in inflation, the adjusted rate (the interest rate minus the inflation
rate) becomes increasingly lower. Or in simpler turns, the money that is paid
back to the lenders is less and less over time. Therefore more money will be
injected into the economy and the wealth transfers form the people lending the
money to the people borrowing the money. At this point the Federal Reserve will
have to step in and raise the interest rates once again to compensate for the
inflation.
It is not bad for inflation to increase at a steady rate, but when
there is an unusual spike in the rate, it hurts the economy because when
regulating interest rates, it will take a long time to feel the full effects.
Another way of looking at how the rate of inflation is affecting the economy is
in terms of the earnings of many corporations. When analysts predict the
estimates for future earnings, the rate of inflation is figured into their
calculations. However in the case of April of last year, the inflation rate as
seen by the CPI increased unexpectedly. Therefore the earnings of many companies
were overestimated, and investors may have overpaid for the price of a
particular share of stock. Conversely the bond market yields were shown as
increasing to a 12 month high. This is accounted by the yield rate being
correlated to the rate of inflation in the economy. As the rate of inflation
increases, so will the bond yield rate to compensate for inflation. In this case
it makes the bond market much more attractive to investors considering the
long-term yields may be higher than other forms of investment.
It is also a
benefit for the Federal Reserve in the sense that as investors choose to buy
bonds, it will remove some of the money supply from the economy. Overall the
Consumer Price Index is an important tool provided by the Bureau of Labor
Statistics that the government looks at closely to determine the growth of the
economy and value of money because of inflation. When there is an unexpected
increase in this rate, the results trickle down to many outlets of the economy
such as the stock and bond markets, which can be clearly seen by the sudden
stock market fluctuation. In the last year the Federal Reserve began to regulate
the economy by increasing interest rates because of the fear of rising
inflation. Time will tell the effectiveness of these measures.
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