Does a CPI Drop Lead to Deflation?

Editor's Note: You can find our complete library of free investing articles here.

Recall late 2008. The Consumer Price Index (CPI) fell for five straight months and the index showed inflation at its lowest rate since 1954. While pundits and news analysts began sowing the seeds for a deflationary environment we suggest these numbers don’t necessarily point to deflation. However, it is a debatable point and worth exploring in detail.

[VIDEO] CPI and Deflation

The first thing we need to understand is that there’s CPI, and then there’s core CPI. When the Bureau of Labor Statistics reports its monthly CPI numbers, it reports CPI numbers and Core CPI Numbers, and each number tells a dramatically different story.

Consumer Price Index for All Urban Consumers (CPI-U)

— The Consumer Price Index for All Urban Consumers (CPI-U) is the broadest measure of consumer inflation used by the government. Basically, it tells us how much prices on nearly almost everything a consumer might buy are rising or falling.

Core Consumer Price Index (Core CPI)

— The Core Consumer Price Index (Core CPI) is a narrower measure of consumer inflation. Core CPI looks at everything the CPI-U looks at except for the price of food and energy. Now, if you’re looking at this and thinking to yourself…”Wait a minute. Aren’t the prices of food and energy pretty important when you’re looking at what typically consumers are spending their money on?”…you’re not alone. Food and energy prices are extremely important.

Each one of these numbers also has a dramatically different affect on the value of the U.S. dollar (USD).

What We Can Learn from CPI Reports

The numbers we saw in the 2008 CPI report told us something extremely important: deflation was not yet a major problem. And in fact, that remains the case to this date.

Specifically, here’s what we learned from the 2008 report:

“Declining energy prices, particularly for gasoline, again drove most of the decline. The energy index declined 8.3 percent in December. Within energy, the gasoline index fell 17.2 percent and accounted for almost 90 percent of the decrease in the all items index. The index for household energy declined 0.7 percent.

“Excluding energy, the index was virtually unchanged for the third straight month. The food index declined 0.1 percent in December, the first decrease since April 2006, as many meat, dairy, fruit, and vegetable indexes decreased. The index for all items excluding food and energy was virtually unchanged in December.”

In other words, the CPI dropped because food and energy prices—which had risen to unrealistic prices during the commodity bubble of the summer of 2008—dropped, not because prices in general dropped. In other words, it appeared that prices were just re-setting, not deflating.


Image courtesy [sic].