The Consumer Price Index (CPI): What Is It?
The Consumer Price Index (CPI), generally known as the CPI inflation rate, is thought to be the most widely used indicator of overall inflation. It gauges changes in the cost of purchasing a fixed basket of representative goods and services and, in general, depicts the country’s inflation rate.
Pakistan’s CPI’s history
For the first time, the consumer price index was calculated exclusively for industrial employees in the cities of Lahore, Karachi, and Sialkot, using 1948–1949 as a base year. By enhancing and extending its breadth and coverage in terms of goods, employee categories, localities, and markets, CPI became more representative over time. As a result, the base years used to calculate the CPI series were 1959–1960, 1969–1970, 1975–1976, 1980–1981, and 2000–2001. At the moment, the base year used to calculate the CPI is 2007-2008. The paragraphs that follow provide more information on the method of index computation and the CPI inflation rate.
Coverage of cities and market selection
The current CPI series includes data from 40 urban areas in Pakistan in order to calculate the CPI inflation rate. 1 to 13 markets have been chosen, depending on the size of the city, from which the prices are gathered. The markets were selected with the amount of sales in mind, presuming that the bulk of consumers purchases goods from these markets. There are 76 markets that are served across 40 cities. Following are the names of the cities and the number of marketplaces in each city:
Income groups
The population under observation is consequently divided into different income quintiles because people’s consumption habits rely on their degree of income. Following are the income quintiles used in the CPI with base 2007-2008:
Basket of goods and services
The basket of goods and services that the current CPI inflation rate includes 487 items from represents people’s preferences, routines, and customs. Based on findings from the Family Budget Survey conducted in 2007–2008, this basket has been created. The twelve main groupings make up the basket of goods and services. Below is a list of commodities group weights:
Consumer pricing collection’s theoretical
underpinnings
Retail outlets and service providers are collecting consumer prices for use in the CPI inflation rate calculation. These are the prices at which consumers can purchase CPI products. In other words, the Pakistan Bureau of Statistics (PBS) gathers market prices rather than lists or tags prices established by manufacturers or various price-monitoring organizations.
The way and how often data is collected
PBS employees working out of 34 Regional/Field offices usually gather CPI inflation rate data every month. According to a predetermined schedule, they individually visit shops, supermarkets, and other institutions to obtain pricing for the chosen items. Schedules were created especially to report prices. The schedules’ contents include the name of the city, the item’s description, and the unit price given by four separate retailers in the market. The following timeline applies to the collection of CPI prices:
Supervision the gathering of price
data
The technical oversight of the work performed by the price collectors is now the responsibility of one statistical officer in each regional/field office. He must make sure that price collectors understand the technical aspects of price collecting and are following the rules outlined in this regard. He must visit the markets to conduct a random pricing check for this reason. The pricing data gathered by the price collectors are also field-checked by the chief statistical officers of the regional offices. To check the validity of the data, senior officers from the head office also conduct unforeseen field inspections or visits.
Insertion of price information
At 34 Regional/Field Offices, data entry software has been created and installed. This software has unique features like comparisons with prior months, average and Centre average computations, and more.
Editing/verification of price schedules
at the corporate level
To ensure its accuracy, price data is reviewed and examined at the headquarters. When there is a question or unusual variance, the relevant price reporting Centre is contacted right away for clarification.
Calculation of market, local, and
national average prices
Four estimates from various stores in a market are gathered for each item. This market’s typical price is determined to be the average of these four quotations. Each item’s city average price is calculated by averaging its prices across all of the city’s chosen markets. Thus, the average of all 40 cities included in the CPI inflation rate is used to determine the national average price of an item.
Weights
Information about the expenditures of households in various income levels, broken down by commodity, is provided via data gathered through the Family Budget Survey. The findings of the Family Budget Survey show the typical percentage of household spending on various goods for each income category in each city. Weights are utilized in the CPI calculation and refer to the average percentage spent on commodities and commodity categories. Different income categories have different weights.
The formula used for the computation of the index
The formula provided below by Laspeyre is used to calculate CPI.
An example of CPI computation
An example can be used to demonstrate how the CPI is calculated. Let’s say we want to determine the pulse index for the month of February 2012 the same is calculated as follows:
As per formula
The indexes for each income group are calculated using the same process using their respective weights and prices. Average prices from 40 cities and combined weights are used to create the overall index to determine the CPI inflation rate.
IMF Inflation Model
According to an IMF working paper, the empirical findings in this research demonstrate that monetary forces control inflation in Pakistan. The main factors that explain inflation trends with a lag of around a year are broad money expansion and private-sector credit growth. The CPI and credit in the private sector are correlated throughout time. Short-term inflation is affected by the wheat support price, but not long-term inflation.
The relative significance of monetary forces and structuralist supply-side factors for inflation in Pakistan is examined in this essay. The currency rate, standard monetary variables (money supply and credit to the private sector), as well as the wheat support price as a supply-side element that has drawn significant attention in Pakistan, are all included in a stylized inflation model that is specified. Monthly estimates of the model are made from January 1998 to June 2005. The findings show that recent inflation has been mostly driven by monetary variables, with a lag of around a year.
The growth track record of Pakistan from the 1970s emphasizes how damaging high and prolonged inflation is to growth. Great inflation periods have often corresponded with periods of low growth, whereas periods of high growth typically occur in low inflation environments. A suitable inflation objective for Pakistan is 5 percent, taking into account the empirical thresholds at which inflation hurts the economy and financial development.
Policy recommendations
Therefore, price stability ought to be the SBP’s main goal. The SBP should first and foremost concentrate its efforts and policies on maintaining inflation or CPI inflation rate near its objective of 5%. The SBP might theoretically target a level of the currency rate as a nominal anchor to achieve macroeconomic stability. However doing so would mean adopting the monetary policy of the anchor nation, which can result in inflation that is not at the desired level.
Additionally, the exchange rate would no longer be available to buffer the local economy from the effects of external shocks. The SBP has all the necessary tools to carry out its autonomous monetary policy under the requirements of the domestic economy. The SBP’s strongest policy contribution to sustainable growth will eventually be to maintain price stability. In the short term, there may not be a trade-off between inflation and growth, but in the medium and long terms, there very definitely is.
Various measures can be used to estimate price stability such as the cpi inflation rate. Although the public understands headline inflation better, it is sometimes asserted that monetary policy should be more focused on core inflation. Core inflation, which is approximated as nonfood, nonenergy, or the SBP’s trimmed mean definition, is a better indicator of underlying inflation trends than headline inflation, given the volatility of some CPI components, particularly food and energy prices.
However, the general public understands headline inflation better because it has an immediate impact on households. When considered as a whole, core inflation is the ideal monetary policy aim, especially over the medium term, but the SBP must also keep a close eye on headline inflation.
Finally, monetary policy needs to look ahead to hit its inflation goal. In Pakistan, the influence of the current monetary situation on inflation is delayed by about 12 months. Twelve months from now, the link between the expansion of private sector credit and inflation appears to be quite constant. Additionally, there is a connection between inflation in 12 months and the rise of broad money. As a result, the SBP should formulate its monetary policy now with an eye on achieving its inflation goal in about a year.
Hardship of CPI Inflation
Inflationary conditions are felt not only in underdeveloped countries but also in developed economies around the world. Two recent studies found that people who own 401(k)s are increasingly borrowing against their future savings to cover unforeseen expenses like funeral costs, unplanned medical expenses, home purchases, post-secondary education or tuition costs, payments to avoid eviction or foreclosure, or to repair unplanned damage to a primary residence.
Vanguard, a financial services company, used information from its 5 million retirement plan members to determine that 0.5% of account holders made hardship withdrawals in October, an all-time high
figure that was deemed “concerning.” This proportion is higher than 0.2% in October 2020 and 0.3% in October last year.
Fiona Greig, global head of investor research and policy at Vanguard, said that the recent rise in households using their employer-sponsored retirement plans “may be a symptom of some deterioration in the financial health of the U.S. consumer.”
Adverse effects of withdrawal due to difficulty
The following effects of withdrawing for hardship, according to the IRS, must be taken into account:
- You cannot “payback” the hardship distribution you get into your account; instead, it will permanently diminish the amount you will have in the plan when you retire.
- You will be required to pay income tax on the previously untaxed retirement savings you receive as a hardship distribution.
- Unless you are 59 1/2 years old or are exempt under one of the IRS’s twelve other provisions, you might be required to pay an additional 10% tax.
- Following the hardship distribution, you might not be allowed to make contributions to your 401(k) for six months.