Understanding Inflation: CPI, Demand, and Structural Factors
Consumer Price Index (CPI)
The Consumer Price Index (CPI) measures the average change in prices of all goods and services purchased by consumers throughout a country. It is obtained by survey and becomes an indicator of the loss of purchasing power of money, i.e., the need for more money to maintain the consumption level before the price increase. That is why it is the most popular indicator.
The CPI is obtained as a weighted arithmetic average of the rates of different groups of goods that form the “basket” made from the Household Budget Survey.
What it gives is the growth rate of the index between two or more points in time. Hence, to measure inflation, we are interested not so much in the price index but in the rate of change in that index.
CPI Limitations
- It is a limited indicator for measuring the overall inflation of the economy because it only refers to a sample of consumer goods.
- Over time, the CPI may not be valid as an indicator of changes in the purchasing power of incomes. With increasing household disposable income, consumer habits change.
- The CPI is not always a coherent and useful indicator in international comparisons because the composition and weighting of goods and services considered in the “basket” may vary from one country to another.
The great advantage of the CPI is its immediacy.
Demand-Pull Inflation
The main cause is the excess growth of demand for goods and services above the economy’s productive capacity. Together with rising prices, the symptoms that accompany this process are an increase in economic activity and employment in the short term and also a trend in the net deficit from growing foreign imports.
Price increases, but…
- Increasing economic activity and cyclical employment.
- Tendency to a Current Account Balance (CAB) deficit and depreciation of the national currency.
Economic policy programs aimed at:
- Limiting government spending on goods and services through a restrictive fiscal policy.
- Limiting spending on private consumption through tight monetary policy with higher interest rates.
Cost-Push Inflation
Source: The autonomous increase in production costs, independent of the movement of aggregate demand (AD), which limits the economy’s productive capacity.
Additional symptoms:
- Decrease in economic activity and rising unemployment.
- External current account deficit less intense than in situations of excess demand due to the dampening effect of reducing imports that accompanies any economic downturn.
Structural Inflation
It is conceived as a structural phenomenon linked to institutional factors that limit the functioning of competitive markets, including labor markets.
- From the perspective of the domestic market: In less competitive conditions, companies can easily move higher costs to prices without fear of reducing their sales and/or benefits.
- From the perspective of the international market: Inflation will be much smaller in an economy the lower the price level of the international economic environment, which is its main market, and the lower the relative weight of the non-competitive and less productive sectors in the aggregate supply (AS) of the economy.