What is inflation and why does it matter?

Inflation: you hear the word all the time on the news. But what is it? Why does it matter? And how does it affect you? Here are the basics to help you understand it better.

In a nutshell, inflation happens when prices go up and people have less purchasing power from the same money.

As a result, when inflation increases, their purchasing power decreases because each dollar they have buys less (and fewer) real, tangible goods than before. For anyone living on a fixed or lower income, inflation is of particular concern.

The hardest part of measuring inflation is establishing prices to use for the formula. National statistics agencies usually measure various inflation rates:

The Raw Materials Price Index (RMPI) – the so-called “crude goods” price index

• Measures commodity price inflation.
• Those are the price changes for raw materials purchased by industries in Canada for further processing.

The Industrial Product Price Index (IPPI)

• Measures changes in the wholesale price of goods at the factory door.
• These refer to commodities sold by Canadian manufacturers.

The Consumer Price Index (CPI)

• Measures the change in retail prices.
• It’s the most frequently used measure of price change.

People often associate the Consumer Price Index (CPI) with inflation.  But what exactly does it show?

• The CPI shows the change in the price of a shopping basket of consumer goods for a country that the national statistics agency has sampled over time on a monthly basis.

The “core CPI” is the change in prices without the food and energy components, or “ex food and energy.”

• Since food and energy prices are volatile, the “core CPI” is thought to be a more accurate measure of underlying inflation.

Keep in mind that because prices can also vary across the country due to local market conditions, supply and demand, and transportation costs, Statistics Canada measures the CPI in each major urban centre to create an accurate sample by province and territory.

It then combines them on a weighted basis to create the National Canadian CPI Index.

• It is not unusual to have major differences, as much as one to two per cent, in the CPI between different provinces and cities. This means where you live has a major impact on whether the CPI is a proper measure of your inflation.

The CPI is considered a fairly accurate reflection of the change in the retail price level in most modern industrial countries. That’s a good thing, because it’s used to index government pensions and benefits, as well as tax brackets.

• It's also used to convert the nominal national accounting statistics, such as Gross National Product (GNP) to a “real” or after-inflation basis, and to calculate the principal increase for inflation-linked bonds.

Not only does inflation impact everything from our ability to purchase retail goods to the value of our pensions, it also potentially exerts an influence over job security and ability to maintain an economic livelihood. That’s why having an understanding of why prices go up and what impact these changes could have on the overall economic picture in the future is important.

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