Inflation seems to be on the rise, as evident by increases in the consumer price index (CPI). However, a recent Economic Synopses essay explored why not everyone feels price increases the same way.
Economist YiLi Chien and Research Associate Paul Morris first discussed how the CPI works. Namely, it measures the average change over time in the prices for a market basket of goods and services. They wrote: “CPI is thus regarded as a measure of the cost of living of an average American.”
However, short-term changes in the CPI can be heavily influenced by changes in food and energy prices, which tend to be volatile. So, some use a measure called core CPI, which excludes these two categories, to gauge inflation. As can be seen in the figure below, core CPI has been much less volatile than overall CPI.
Even with these two measures, consumers may still not see how inflation is impacting their specific situations. As Chien and Morris wrote: “Because consumption decisions vary from person to person, very few Americans consume the average market basket measured by the CPI.” To explore this further, the authors examined two areas that make up significant portions of the average household’s spending: housing and medical expenses.
The figure below shows the year-over-year inflation rate for housing services (shelter), which make up about 20 percent of an average household’s spending, compared to core CPI.
As the figure shows, housing costs have been trending upward. However, this trend affects various groups in very different ways.
For example, Chien and Morris noted that the Bureau of Labor Statistics (BLS) actually calculates the value of the service that housing provides, rather than the value of the housing itself. For renters, this would be the cost of rent, so inflationary pressures associated with housing services would have a direct effect.
For homeowners, though, the BLS calculates implicit rent, or how much they would pay to rent their home if they didn’t own it. Implicit rent may rise, but it wouldn’t actually affect this group’s housing costs.
Regarding medical services, which make up about 8 percent of an average household’s expenditures, Chien and Morris noted that the inflation rate rose from 1.8 percent in February 2015 to 5.1 percent this past August, as shown in the figure below.
Of course, not everyone consumes medical services at the same rate. The authors cited a 2004 paper that found that nearly half of lifetime medical expenses typically occur after age 65.1 They wrote: “In addition, health insurance coverage has a significant impact on how much individuals spend on medical services. For those without health insurance, rising costs directly correlate with out-of-pocket medical expenditures. And the cost increases could be significant relative to total income.”
Chien and Morris concluded by noting that inflation, core inflation and housing services inflation are all still lower than before the 2007-09 recession, though medical services inflation is higher. They wrote: “Inflation has been on an upward trend recently; and if inflation rates continue to pick up, the increases are likely to impact various subsets of the population more than others.”
1 Alemayehu, Berhanu; and Warner, Kenneth E. “The Lifetime Distribution of Health Care Costs.” Health Services Research, June 2004, Vol. 39, Issue 3, pp. 627-42.