How Will Inflation Affect You?
You’re probably at least somewhat familiar with the Consumer Price Index (CPI), the Bureau of Labor Statistics (BLS) measure of inflation. Considering that this metric is the fundamental driver of government programs ranging from the setting of short-term interest rates to Social Security’s cost of living increases, its importance in our lives cannot be overstated. But do you know how the CPI is calculated, and how relevant it really is for your particular lifestyle and financial situation?
The CPI consists of eight categories of expenditures, with each weighted based on its assumed impact on urban consumer spending. The categories and their weightings are:
• Food (14%)
• Housing (42%)
• Apparel (3%)
• Transportation (16%)
• Medical Care (9%)
• Recreation (6%)
• Education & Communication (7%)
• Other (3%)
In other words, the cost of housing is expected to absorb 42% of the average consumer’s budget, followed by transportation costs at 16% and food and beverages at 14%. Note that motor fuel as well as home heating fuel costs – part of a separately-tracked energy component – are included in the Transportation and Housing categories respectively. The Food category includes alcoholic beverages but not sodas. The last category is comprised of a random assortment of expenses such as cosmetics, financial services, tobacco, and funeral expenses.
Not surprisingly, since the year 2000 the CPI component with the highest cumulative increase has been Medical Care at 91%. But although college tuition and fees have grown by over 150% throughout the same period, only a fraction of those costs is included in the Education and Communication category, which explains why its total increase amounted to less than 34%. By the same token, Transportation and Housing costs have increased less than 60% each despite overall energy costs having risen well over 100% since 2000.
The problem with this measure is that it assumes a fixed budget for an average U.S. consumer. The fact is there really is no such thing.
Imagine a dual-income family with no children living in the outskirts of Sacramento and commuting to work in the city by car. Their transportation costs are likely to be a larger percentage of their budget than 16% given the state’s high gasoline costs. At the same time the education portion of their budget is probably much lower than the BLS’ estimate. Compare that to a family living in San Francisco having one spouse with diabetes. Their medical costs are probably much higher and their transportation costs much lower than those of the family above. And a family with a similar situation but living in Iowa is likely to face very different costs for the very same budgetary categories.
Notwithstanding the differences in the above lifestyles, there are also the financial shifts that we experience as we age. If the SF family above has two children, their education costs are going to skyrocket once the kids go off to college. And after all these families retire, their medical costs are going to become a higher and higher percentage of their overall spending, far more than the CPI would indicate.
As of June the CPI was up nearly 2.9% year-over-year. The increase in Core CPI, which excludes the more volatile food and energy categories, rose a bit less than 2.3%. Although the Fed traditionally uses the Personal Consumption Expenditure price index as their preferred inflation gauge, all indicators are exceeding the Fed’s inflation target of 2.0% and point to the likelihood of more interest rate hikes this year. Notwithstanding, even if such actions help to reduce the overall CPI, how will that benefit you? It depends on your lifestyle.
Inflation becomes a concern if it gets out of hand, and with the tax reduction of 2017 further stimulating what had been an already robust economy, the likelihood of it ramping up is now quite high. But the impact on each of us as consumers will vary widely. Unfortunately as always, rampant inflation tends to pose the greatest problem for lower-income workers and seniors on fixed incomes with limited discretionary spending ability.