What is driving the rise in inflation?

Consumer prices rose 7.9% in February 2022 compared with the same month last year, according to the Consumer Price Index for urban consumers. February had the highest 12-month increase in 40 years.

While inflation has been rising since November 2021, prices aren't rising at the same rate for all goods and services. And the most commonly used government measure for inflation doesn't treat price increases from each type of good or service the same way.

How do price increases affect the CPI?

To measure consumer prices, the prices of common consumer goods and services are factored into a measure called Consumer Price Index or CPI. The most used version of the CPI is the CPI-U, which focuses on prices in urban areas.

All the prices in the CPI-U are given a weight based on their "relative importance," or percent of average total consumer spending in the US. Each good or service is grouped into one of eight categories: housing, transportation, food and beverage, medical care, education and communication, recreation, apparel, and other.

For example, food and beverage prices account for 14.26% of the CPI-U. But the index isn't assuming that everyone spends that exact amount of their income on food and beverage every month. For example, households spend an average of 11.9% of their income on food, while a household with a single parent spends 13.5%. Similarly, prices for goods and services aren't the same throughout the country. So the CPI-U averages expenditures across multiple US cities to account for those differences in prices.

Housing holds the most weight in the CPI-U, accounting for 42% of the index. In addition to rent and mortgage payments, the category includes utilities and other energy costs associated with living in a home. Transportation has the second-highest weight in the index at 18%. That category includes new and used cars, gasoline, and public transportation.

Because of the index's weight, extreme increases in price for one item or category do not force the CPI-U to increase by the same amount. For instance, the cost of used cars and trucks increased 41.2% from February 2021 to February 2022, but it accounted for 4.1% of the CPI-U value.

Which goods increased the most in price since February 2021?

Fuel oils, a type of oil used primarily for industrial purposes, had the largest increase in price since February of last year at 43.6%. However, fuel oils account for less than 1% of CPI.

Other energy goods and services had some of the most significant price increases compared to February 2021. Overall, energy prices increased by 25.6%, while gasoline and other motor fuel prices increased by 38.1%. Energy goods and services, included in the housing and transportation categories, account for 7.3% of CPI.

Transportation commodities, such as new and used vehicles, and vehicle parts or equipment, increased by almost 24% since last year. Used cars and trucks alone were 41.2% more expensive. These items account for 8.8% of CPI.

However, not all items factored into the CPI-U rose in price. For example, smartphones and meals at primary and secondary schools decreased by 13.2% and 53.3%, respectively. They account for less than 1% of the CPI.

How does current inflation compare with the past?

As prices rise, currency loses value, and it doesn't have as much purchasing power as it once did. In other words, whatever a dollar can buy is reduced over time.

In the last 75 years, consumer prices increased by more than 7% in a 12-month period five times. The most dramatic increases in inflation were connected to oil supply shocks. In 1974, the cost of energy goods and services increased an average of 30% compared with the year before. In 2021, they rose about 20% compared with 2020.

Due to prices increasing over time, it's misleading to look at the price of something in 2000 and compare it directly with the price for that item today. Instead, monthly CPI data can pinpoint how purchasing power and prices have changed over time. By using that data, it is possible to convert historical prices into current dollars, making the prices of goods and services comparable across the years. For example, spending $1.41 for a gallon of gas on February 28, 2000, is the equivalent of paying $2.36 a gallon in February 2022.

How is the federal reserve addressing inflation?

In an attempt to slow rising inflation, the Federal Reserve increased the federal funds rate to a target range between ¼ and ½ percent. The federal funds rate is the rate at which banks lend to each other. The previous range was near-zero to encourage spending during the pandemic.

The Fed also said it would soon begin the sale of Treasury securities and other debt to reduce the amount of money circulating in the economy. The Fed expects this will reduce inflation.

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