If you’re having a cup of Maxwell House before jumping in your new Toyota Celica GT and heading for the mall to buy play clothes for your child, you already know a lot about the cost of living.
Start with the coffee. Brazil has suffered two frosts and a drought in recent months, so coffee harvests are stunted and wholesale prices are soaring. A 13-ounce can of Maxwell House was recently $3.29, 65 percent above last January’s $1.99.
The Celica GT? The ’95 two-door coupe is sticker-priced at $19,288, a 4.7 percent jump over ’94. Toyota blames part of the increase on the rising yen. When Japanese currency becomes more valuable, it takes more dollars to buy Japanese products.
But there’s good news at the mall. Clothing prices are down 0.2 percent, led by a 2.4 percent drop in the price of infants’ and toddlers’ wear.
Where is the cost of living headed? Based on the headlines, you might think raging inflation is in store. But you can rest easy: The consumer price index will probably rise about 3.5 percent in 1995, compared with 3 percent for ’94.
The sweeping Republican gains in Congress will have little impact on inflation, good or bad, in the next 12 months.
“Inflation in 1995 is pretty much baked in the cake,” says John Makin, an economist with the American Enterprise Institute, a conservative think tank in Washington. However the election results affect inflation in the future, it will stay relatively subdued this year.
“There will be inflation,” says Don Ratajczak, director of the Georgia State University Economic Forecasting Center, “but not anything of worrisome proportions.”
He expects inflation to heat up in only two categories: housing and medical care. Housing costs could jump 3.5 percent (up from roughly 2.5 percent in 1994) because of the increased demand for rental properties. Ratajczak thinks 1994’s hike of 4.6 percent in medical expenses may give way to 5.5 percent this year.
Wages will outpace inflation, but not by much. Pay increases are expected to average 4 percent, just half a percentage point above the expected rise in the cost of living.
The problem with such numbers, of course, is that they’re averages. If you received a 7 percent raise for 1995, you might think you’re sitting pretty, with your disposable income handily outpacing inflation. That’s great if you face average inflation. But a couple of kids in college, and an adjustable-rate mortgage about to step up two percentage points could make that pay raise seem paltry.
You can figure your personal inflation rate by using the method shown on the cover page. But first, a quick review of where the official inflation numbers come from.
The Bureau of Labor Statistics (BLS) is the nation’s inflation umpire, and the monthly consumer price index (CPI) figures are the box scores. The CPI tracks price changes across a wide range of consumer goods and services: toddlers’ apparel and eye shadow, beer and premium unleaded gas, ham and home repairs-hundreds of household expenses that, taken together, paint a picture of inflation. Since we ordinarily spend more on housing than on sporting goods, the CPI assigns weights to various spending categories.
The current category weights are: housing, 41 percent; food and beverages, 17; transportation, 17; medical care, 7; apparel, 6; entertainment, 5; and other, 7. (The numbers don’t add up to 100 because of rounding.)
Each category is made up of dozens of individual items, and each of these gets its own weight. Once the BLS knows the price increase on each item, it calculates the CPI.
Housing, for example, accounts for 41 percent of a typical household budget. So when housing costs rise at a 2.5 percent annual rate, as they did recently, that equals 1.03 percent of inflation (0.025 times 0.41).
Hikes in lower-weighted categories have correspondingly less effect. Transportation costs were recently up 4.4 percent on an annualized basis, in part because new-car costs have increased. However, transportation costs are only 17 percent of the typical budget, so that stiff 4.4 percent increase amounts to 0.75 percent of official inflation (0.044 times 0.17).
The journey to a personalized CPI begins with the recognition that everyone spends money differently. Relatively few young adults need to spend 7 percent of their budget on medical care, for example, while 70-year-olds are likely to spend more, and so forth.
Your own spending habits create a unique CPI, which you can begin to calculate by filling out the work sheet. It lets you see how the overall inflation rate in each category, when applied to your own spending, affects your cost of living.
This measure is imperfect, however, because your particular spending in each category may result in a significantly different inflation rate of that category.
For example, because the CPI relies on a fixed market basket of purchases, some critics say it overstates inflation because it does not factor in substitutions. That is, if beef prices are sky high one week, the CPI reports the hike. In real life, however, consumers may very well look at high beef prices and buy chicken instead. BLS officials concede this “substitutions effect” might indeed cause the annual CPI to be overstated by about 0.2 percent.
Other realities could have far more impact. Let’s look at housing costs, for example. The BLS calculates that spending in this category, which measures everything from house payments to lawn care to long-distance phonce calls, takes 41 percent of the average consumer’s budget.
For the 12 months that ended Oct. 31, the BLS reports that these costs were up 2.5 percent. For CPI purposes, then, housing cost increases were responsible for about 1 percent of inflation (0.41 times 0.025).
Your personal housing inflation rate might be wildly different, though. If you’ve lived in the same house for 15 years and your mortgage payment has remained the same while your income has risen, perhaps only 20 percent of your spending goes for housing. And the inflation rate for that part of your spending may be below the 2.5 percent average for the category because your mortgage payments are fixed.
On the other hand, if 20 percent of your spending goes to your mortgage payment alone, and you face a two-point bump-up in your ARM rate, your housing inflation rate is raging.
It’s how you spend your money that determines your personal inflation rate. Completing the work sheet will give you a better idea of where you stand than anything you read in the papers.
