Chapter 23 — Key Takeaways

CPI construction

The CPI measures the cost of a fixed basket of ~80,000 goods. BLS price collectors visit thousands of outlets monthly. The index is set to 100 for 1982–84. Current CPI ~320 (prices 3.2× higher than the base period).

Inflation rate = (CPI_current − CPI_previous) / CPI_previous × 100.

Three biases (each overstates true inflation)

  1. Substitution bias — consumers switch to cheaper alternatives; the fixed basket doesn't adjust
  2. New goods bias — new products enter the basket with a lag, missing early price declines
  3. Quality bias — products improve but the CPI doesn't fully account for quality gains

Combined: CPI overstates inflation by ~0.5–1.0 ppt/year. The Chained CPI partially addresses substitution bias.

Core vs. headline

  • Headline = all items (what you experience at the store)
  • Core = excludes food and energy (less volatile, what the Fed watches)
  • The Fed targets 2% core PCE inflation

Real vs. nominal conversion

Real value = Nominal value / (Price index / 100). Nominal wage growth that doesn't exceed inflation = real wage decline.

Six costs of inflation

  1. Redistribution (debtors gain, creditors lose)
  2. Shoe-leather costs (managing cash to avoid inflation losses)
  3. Menu costs (frequent price changes)
  4. Tax distortions (taxing nominal gains, not real)
  5. Uncertainty reduces investment
  6. Confuses relative vs. general price signals

Costs of deflation (even worse)

  1. Debt burden increases (crushes borrowers)
  2. Consumers delay purchases (deflationary spiral)
  3. Zero lower bound limits monetary policy
  4. Historically associated with depression

Central banks target 2% (not 0%) to provide a buffer against deflation.

The 2021–23 inflation episode

CPI peaked at 9.1% YoY in June 2022. Three causes: supply-chain disruptions, fiscal stimulus, and their interaction. Fell back toward 2% by 2025 through supply healing + aggressive Fed rate hikes + anchored expectations. Hurt low-income households most; benefited borrowers.

Themes

  • Data tells stories — CPI is a measurement choice
  • Disagreement — about 2021–23 causes
  • Affects daily life — grocery bills, wages, mortgages