what is IPC and how does it work

Price trends determine the consumption, investment and debt decisions of companies and households, as well as the design of a country’s economic, social, fiscal and monetary policies.

Persistent inflation (widespread and prolonged rise in prices) or lasting deflation (continuous fall in prices in the economy) have a negative impact on society. How much the more stable the price level remains and, therefore, the greater the value of money over time, the greater the welfare of society, since greater certainty is generated. For this reason, central banks aim their monetary policy to keep inflation under control.

What is the IPC and how is it prepared?

The consumer price index (CPI) is a numerical indicator which explains and summarizes the evolution of the prices of a set of goods and services representative of household consumption.

It is a weighted index: the prices of each good or service that composes it have a different relative importance, according to the share of household expenditure devoted to the consumption of each good or service.

In order for the calculation of the index to allow the comparison of prices over time, a reference reference year is chosen, from which the prices of successive periods will be estimated and interpreted. But also, over time, it is necessary to update this base year, so that the index retains the representativeness of the household consumption basket, which evolves according to the evolution of societies.

The Spanish CPI

In Spain, the origin of the CPI dates back to 1939 (p.18)when he National Institute of Statistics established the first system of cost of living indices for each province, in which the prices of 95 to 139 items per province were taken into account.

Since then, different base periods have been taken for the CPI. The last of these was 2021, during which updated cart contains 955 items compared to 977 in the previous database, established in 2016.

Some 220,000 prices are processed monthly to compile the CPI. Changes in this index from period to period (year to year, month to month, etc.) are a measure of inflation.

Both to choose the products that enter the basket and to establish their weighting, the INE takes into account the data of the Family budget survey. This survey is carried out annually among 24,000 families and provides estimates of their expenditure on consumer products.

If families buy more perishable foods than packaged foods, the price of perishable foods should have more weight in the cost of living measure. The same is true for other product groups, from insurance to electricity to education.

Currently, for the preparation of the CPI, the items are classified into 12 groups with different weights which are updated every year according to the latest information from the family budget survey.

Weightings (in %) in the CPI of the groups of goods and services that compose it.
Source: Own elaboration based on INE data

The evolution of the CPI over the last two decades can be observed in the following table:

Evolution of the CPI in Spain between 2002 and 2022.
Source: Own elaboration based on INE data

If in 2002 the level of the index was around 70, in 2022 it is close to 110. In other words, in 20 years it has increased by around 57%. Thus, accumulated inflation over the past two decades has been around 57%. In other words, the cost of living has increased and to buy the same thing, you need 57% more money.

Considering that 20 years have passed, the increase is moderate. However, if incomes were not updated according to the index, citizens would have lost a lot of purchasing power.

If we compare the level of the CPI for the last one-year period available, we obtain the annual inflation rate. By June 2022, the CPI forecast in Spain it rose to 10.2%, the highest level since April 1985.

The percentage change in the price index between two periods is called the inflation rate. The rate of inflation directly measures the loss of purchasing power although, as can be seen in Table 2, prices do not always rise. For example, 2014 and 2002 ended with a negative inflation rate. In other words, at the end of the two years, more consumer goods could be purchased than at the beginning with a given amount of money.

The harmonized CPI

In order to be able to compare inflation data with those of neighboring countries, in particular those of the EU, since 1997 Spain has calculated the Harmonized Index of Consumer Prices, or IPCA, following the methodology and weightings defined by Eurostat, the European statistical agency. This is the clue use the ECB guide its monetary policy.

The IPCA covers consumption expenditure made by all households within the economic territory of each EU Member State, whether they are resident there or not. For its part, the CPI considers expenditure made only by residents, whether on the territory of the country or abroad.

Moreover, the weights of the different groups of goods and services are slightly different. There is even some difference in the products that the two indices include in their respective consumer baskets. However, the values ​​of both are very close, as the similarity between them is very high.

core inflation

The concept of core inflation measures the evolution of prices after removing energy and unprocessed food from the index. These components are commodities generally listed on international markets and subject to high volatility.

Underlying inflation makes it possible to capture the evolution of the prices of the most stable products in the consumption basket and makes it possible to anticipate whether the rise in prices will be temporary or, on the contrary, whether it will be more persistent.

The core inflation forecast for May 2022, it rose to 4.9%. This indicates that the inflationary pressures generated by the prices of energy and raw materials are transferred to the rest of the products.

CPI and its applications

The information obtained from consumer price indices and many applications in which this short-term indicator of the economy is used is very extensive.

The CPI is considered in reviews of salaries, pensions, insurance premiums, rents, updates and investment appraisals and ultimately in reviews of any contract or resolution where it is necessary to counter the loss of the value of money and thus convert our unstable economic unit of measurement into a stable and homogeneous one despite the passage of time.

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