Home' Trinidad and Tobago Guardian : June 22nd 2014 Contents This article looks at inflation and the
economy. It outlines the different ways
inflation can be measured, along with the
strengths and weaknesses of each metric.
It also suggests some of the implications
for personal financial management.
The term "inflation" figures
importantly in discussions of
finance and investment. But
many kinds of numbers may
be bandied about, and they
don't all mean the same thing.
Here's an overview of the principle measures
• The Consumer Price Index (CPI) measures
the changes in price for fixed baskets of com-
mon consumer goods and is intended to show
how changing prices impact consumer spend-
ing power from month to month.
The CPI assumes that the consumer would
be buying the same quantities of identical
goods each month.
As a result, the CPI does not fully capture
the impact of structural changes on individual
buying behavior, such as purchasing a more
fuel-efficient car in response to a spike in
energy prices. Many consumers use changes
in spending patterns to free up resources and
lessen the impact of inflation on other pri-
The CPI also assumes that each price change
hits every consumer equally. However, some
consumers may bear the brunt of some price
changes disproportionately. For example, a
sharp change in home prices would not have
any immediate effect on most homeowners'
actual monthly spending priorities even though
the change would impact reported CPI.
• The GDP Implicit Price Deflator shows
how changes in price levels impact the econ-
omy from quarter to quarter. It was developed
by economists who wanted to see how much
of any given change in GDP represented real
growth in output, and how much was simply
the result of changes in prices.
The deflator uses price comparisons for
every element included in GDP and weights
those comparisons according to the item's
weight in the latest economic snapshot. As
a result, the deflator is instantly responsive
to shifts in economic patterns, affording
increased influence over the inflation tally to
growing sectors and decreased influence to
• The Chained CPI is the newest inflation
benchmark, existing in its current form for
little more than a decade, compared with the
century's worth of history in the original CPI.
Where the original relies on inflexible formulas
and rigid weighting, the chained CPI is meant
to capture the effects of consumer substitu-
tions. For the years when the chained CPI
has been calculated side by side with the orig-
inal CPI, the chained CPI has generally shown
Economists debate which metric better
captures consumer experience.
Measured across the grand sweep of the
economy's ups and downs, average inflation
has appeared moderate.
Over the long term, there appears to be
little practical distinction between measure-
ments produced by the CPI and the GDP
deflator. But narrow the focus and important
distinctions can appear. For example, during
crushing price volatility sparked by the OPEC
oil price shocks, there were potentially sig-
nificant differences in the amounts of inflation
recorded by each of the metrics.
Inflation assessments are embedded in
many financial decisions. In retirement plan-
ning, underestimating inflation can leave you
short of income later in life; overestimating
it can lead to unnecessary sacrifice.
In the context of evaluating a potential
investment, a proper assessment of inflation
potential can help determine whether the
proposed investment could compensate for
the loss of purchasing power as well as the
risk you've assumed.
Understanding inflation trends can be a
key to financial and investing success. Using
metrics properly is an essential part of that
understanding. If you would like to discuss
how inflation affects your financial strategies,
please call me.
The US>CPI Index is a measure of the aver-
age change in prices over time in a fixed
market basket of goods and services. The
index is for all US Urban Consumers, which
covers approximately 80 per cent of the non-
institutionalised civilian population.
This index is seasonally adjusted. Seasonal
adjustment removes the effects of events that
follow a more or less regular pattern each
year. These adjustments make it easier to
observe the cyclical and other non-seasonal
movements in a data series. Due to availability
this is an estimated return until the 15th busi-
ness day of each month, which is then revised
to the finalised return.
Article by Wealth Management Systems, Inc.
and provided courtesy of Morgan Stanley Financial
The author(s) are not employees of Morgan
Stanley Smith Barney LLC ("Morgan Stanley").
The opinions expressed by the authors are solely
their own and do not necessarily reflect those
of Morgan Stanley.
The information and data in the article or pub-
lication has been obtained from sources outside
of Morgan Stanley and Morgan Stanley makes
no representations or guarantees as to the accu-
racy or completeness of information or data from
sources outside of Morgan Stanley. Neither the
information provided nor any opinion expressed
constitutes a solicitation by Morgan Stanley with
respect to the purchase or sale of any security,
investment, strategy or product that may be
© 2014 Morgan Stanley Smith Barney
LLC. Member SIPC.
JUNE 22 • 2014 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
FINANCIAL PLANNING | SBG15
DAVID H FOX
Putting a perspective on
Source: Bureau of Labor Statistics (Consumer Price Index); Bureau of Economic Analysis (GDP Implicit Price Deflator).
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