Big Drops In US CPI, Housing Signal Tough Economic Times

WASHINGTON -- U.S. consumer prices posted a second-straight record decline last month, a government report showed, suggesting tumbling energy prices and the slumping economy are rapidly taking pressure off inflation and could even lead to sustained price drops known as deflation.

Meanwhile, housing starts plunged to a record low, signaling that the severe downturn in homebuilding will drag well into 2009 and exert even more pressure on the economy.

The reports suggest Federal Reserve officials will slash official interest rates to record lows at the conclusion of their two-day meeting Tuesday to prevent a self-feeding spiral of lower prices and falling spending and investment.

The consumer price index fell 1.7% last month, the Labor Department said Tuesday, the largest monthly decline since the government started compiling the figures in 1947 and well in excess of the 1.3% decline Wall Street economists had expected.

The core CPI was unchanged following October's decline, which was the first in more than 25 years.

Tuesday's CPI data follow record declines in import and producer prices for November.

Normally, such signs of rapid price drops would be hailed as a welcome reprieve for households that saw their purchasing power crippled earlier in the year by soaring energy and food prices. But in the current climate, the inflation data reflect the hard economic times that are causing consumers and businesses to delay purchases. In its worst form, that process is known as deflation, which was blamed for Japan's deep economic slump earlier this decade.

Against that backdrop, and with the economy in a deep recession, financial markets expect the Fed to lower official interest rates by at least one-half percentage point to just 0.5% at the conclusion of Tuesday's meeting. The decision is expected around 2:15 p.m. EST.

Consumer prices rose just 1.1% on a year-over-year basis in November, which is below the Fed's 1.5% to 2% target range. Last month's annual rate matched the lowest reading since February 1965 and marks a stunning reversal since July, when the year-over-year rate reached 5.6%. Over the past three months, consumer prices have fallen at a 10.2% annual rate.

Another decline in the December CPI, were it to occur, could push the annual rate close to zero.

The core CPI, however, was up 2% from last year, suggesting the U.S. isn't yet at serious risk of economy-wide deflation.

Barclays Capital economist Zach Pandl noted that while prices of energy-related products and economically sensitive goods like automobiles are down, "the kinds of stickier, trend inflation components are definitely not accelerating but are also not turning down significantly."

Energy prices plunged 17% in November compared with October. Gasoline prices plummeted a record 29.5%.

Food prices, in contrast, climbed 0.2%.

Transportation prices fell a record 9.8% as airline fares dropped 4% and new vehicle prices fell by 0.6%, reflecting the severe slump in auto sales.

Housing, which accounts for 40% of the CPI, fell 0.1%, the third decline in four months. Rent increased 0.2%. Owners' equivalent rent advanced 0.3%. However household fuels and utilities prices tumbled 1.6% while lodging away from home fell a second-straight month, by 1.1%.

Medical care prices increased 0.2%, while clothing prices rose 0.3%, though that reversed only a portion of the previous month's 1% decline.

By Brian Blackstone, Dow Jones News Wire

Regarding the potential use of the CPI-E Index.

I was searching for a way for Financial Planners and Individuals to better gain a handle on the inflation expectations when planning income generation from their investment accounts in retirement.

I contacted several professors at Wharton and finally the U.S. Department of Labor.  The Labor Department releases the CPI-U which is reported monthly and used by most individuals and planners when calculating inflation expectations throughout their financial lives.

However, seniors will be faced with a different set of expenditure weights than the rest of the population. A 67 year old will be spending a larger portion of his/her income on healthcare, prescription medications and travel than a 40 year old.

To address that issue the department of labor has gathered inflation expectation data for this set of the population calling it the CPI-E (Elderly). Since the statistics are based off of the CPI-U instead of specifically being gathered for this population set, there is a greater chance of a sampling error and therefore the index is unpublished and considered experimental but accurate.
           
However, common sense tells us that the expenditure weighting for this subset is higher in certain areas and the CPI-E does attempt to take into account this fact by adjusting these weightings. .

This data is sent to me monthly by The Bureau of Labor and Statistics. The data, I believe does not take into account sufficiently the higher expenditure for health care that will ultimately face the bulging baby boomer population and their expected increase use of the healthcare system. But for now, the CPI-E is the best index we have.

This adjusted index, for which the adjustments and how they were arrived, along with the limitations can be accessed monthly on this web page.  A new index which hopefully will be used by planners to gauge the expenses of their clients as they move into the retirement and withdrawal/distribution phases of their financial lives.

The goal is to provide more accurate inflation data to seniors.

If the index is adjusted too high, then individuals will have a conservative financial plan in place. Either way, the CPI-U being used today for retirement planning is the wrong index to use. The CPI-E is the right index.

We will be releasing the index monthly and hope that financial advisors will use the index to prepare seniors for retirement.

The Limitations of the Unpublished Experimental Consumer Price Index

for Americans 62 Years of Age and Older

In addition to  the official CPIs for All Urban Consumers (CPI-U) and Urban Wage Earners and Clerical Workers (CPI-W), the CPI calculates an experimental price index for Americans 62 years of age and older. There are several limitations in  the experimental price index which must be considered and understood by potential users of the data.  The limitations include:

Expenditure weights: The 2003-04 Consumer Expenditure (CE) Survey is used as the source of expenditure weights for the official CPI series, the CPI-U and the CPI-W. The CE Survey sample was designed to collect expenditure patterns representative of the CPI-U population.  The experimental index also used expenditure weights from the CE Survey where the reference person was 62 years of age or older. Since the CE Survey sample design did not specifically target the ‘62 and over’ population, the number of consumer units used for estimating weights in the experimental index was relatively small--about 22% of the urban CE Survey’s sample.  The expenditure weights used in the construction of the experimental price index would thus be expected to have a higher sampling error than those used for the larger, official populations.

Areas and outlets priced: The experimental consumer price index is a weighted average of price changes for the same set of item stratum and collected from the same sample of urban areas used in calculating the CPI-U and CPI-W.

Retail outlets are selected for pricing in the CPI based on data reported in a survey[1] representing all urban households.  The experimental index also uses the same retail outlet sample. The outlets thus selected may not be representative of the places of purchase for older Americans. 

Items priced: The categories of items to be priced are selected using expenditure weights calculated from the expenditure surveys for the urban (CPI-U) population.  As a result, the specific item classes and unique items selected to represent the total urban population  may not be representative of the experimental index population.

Prices collected:  A final source of uncertainty about the appropriateness of using the CPI-U prices for the index of the older population concerns the availability of discount prices for older Americans.  For example, senior-citizen discount rates are used in the CPI in proportion to their use by the urban population as a whole. This approach is accurate for the estimation of an index which represents all urban consumers, but would be expected to understate the use of this type of discount in the experimental population.

Because of the above limitations, any conclusions drawn from these analyses should be treated as tentative.

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