Chapter 23 — Exercises

Section A — CPI and inflation rate

A1. The CPI was 297 in January 2023 and 308 in January 2024. What was the year-over-year inflation rate?

A2. In 1980, the CPI was about 82 (1982–84 = 100). In 2024, it was about 315. By what factor have prices risen since 1980?

A3. A worker earned $25,000 in 1990 when the CPI was 131. In 2024 the CPI is 315. What is the 1990 salary in 2024 dollars?

A4. If inflation is 3% per year, how long does it take for prices to double? (Use the Rule of 70: 70/growth rate.)

A5. Core CPI rose 3.8% YoY in a month when headline CPI rose 5.2%. What does the gap tell you?

Section B — Real vs. nominal

B1. Your nominal wage rose from $50,000 to $55,000 (10% increase). Inflation was 7%. What happened to your real wage?

B2. A house cost $120,000 in 2000 (CPI = 172) and $320,000 in 2024 (CPI = 315). Did the real price of the house rise? By how much?

B3. The federal minimum wage has been $7.25 since 2009, when the CPI was about 215. The CPI in 2024 was about 315. What is $7.25 in 2024 real dollars?

B4. An investment earned a nominal return of 8% in a year when inflation was 5%. What was the real return?

Section C — CPI biases

C1. Give one example each of substitution bias, new goods bias, and quality bias.

C2. The Boskin Commission estimated the combined CPI bias at about 1.1 percentage points per year. If this overstated real Social Security COLA adjustments for 20 years, by how much would cumulative benefits have been overstated?

C3. Why does the Chained CPI grow more slowly than the standard CPI? Should Social Security COLAs use the Chained CPI?

Section D — Costs of inflation and deflation

D1. You borrowed $200,000 at a fixed 4% interest rate. Inflation unexpectedly rises to 6%. Are you better off or worse off? What about the lender?

D2. "A little inflation is actually good for the economy." Use the deflation argument (zero lower bound) to explain why central banks target 2%, not 0%.

D3. Japan experienced deflation for most of the 1990s and 2000s. What were the consequences? Apply the four costs of deflation.

D4. Venezuela experienced hyperinflation in the 2010s and 2020s (inflation exceeding 1,000,000% at peak). What happens to an economy during hyperinflation?

Section E — The 2021–23 episode

E1. "Inflation was caused by too much stimulus." "No, inflation was caused by supply-chain disruptions." Evaluate both claims. Why is the honest answer "both"?

E2. The Fed raised rates from near-zero to 5.25%. How does this reduce inflation? Trace the transmission mechanism (rate → borrowing → spending → output → prices).

E3. Low-income households were hit hardest by the 2021–23 inflation. Why? (Hint: budget shares for food, gas, and rent.)

E4. "Inflation expectations remained anchored." What does this mean and why did it matter for bringing inflation down?

Section F — Data lookup

F1. Look up the current CPI on FRED (CPIAUCSL). What is the latest year-over-year inflation rate?

F2. Compare headline and core CPI (CPILFESL for core) over the last 5 years. When did they diverge most?

F3. Look up the CPI for "shelter" (CUSR0000SAH1). How has shelter inflation compared to overall inflation since 2020?

Section G — Reflection

• Has this chapter changed how you think about "prices going up"?
• Which cost of inflation do you think is most important for ordinary people?
• Do you think the Fed handled the 2021–23 inflation well? What would you have done differently?

Selected answers in appendices/answers-to-selected.md.