smart spending

Is inflation higher than you think?

Wheat grains and coffee beans
Highlights
  • The core inflation rate eliminates food and fuel due to their volatility.
  • Commodities account for a small percentage of packaged food prices.
  • Price changes in commodities have short-term and long-term effects.

If you've noticed your wallet seems a little lighter after a trip to the grocery store or gas station, you're not imagining things.

Here and around the world, the prices of everything from cotton to coffee have risen. The Department of Agriculture forecast for food costs in 2011 calls for an increase of 3 percent to 4 percent. And, the price of fuel is up -- a lot.

Yet, the government's measure of inflation, the Consumer Price Index, barely registers an increase in the prices consumers are paying. Economists don't expect an inflation increase of more than 1.5 percent this year, "even if food goes up 3 percent and energy goes up 10 percent," says Bill Hampel, chief economist for the Credit Union National Association.

The index vs. actual cost of living increases

What gives? Don't food and fuel prices count in the tabulation of the index? Not really.

To measure the cost of living for consumers and come up with the Consumer Price Index, the Bureau of Labor Statistics prices everything consumers spend money on. Then all of the expenditures are categorized and weighted based on the amount that the average consumer spends on those categories. The percentage change from month to month is the rate of inflation, and it's usually expressed as an annualized number.

The all-items inflation rate represents everything people spend money on: haircuts, plane tickets, medical care, clothes -- you name it. But, that number is puffed up by the pesky necessities -- food and energy. So those two categories are discarded when calculating the core inflation rate.

Theoretically, the core inflation rate more accurately reflects the increase in costs without factoring in the capricious nature of weather and political winds that impact food and fuel costs.

"Food and energy prices are quite random," says Hampel. "Usually our best guess of inflation going forward for the next few months is anchored at the core rate."

Nevertheless, food and energy prices have increased at a much quicker pace than core items. Food prices increased at nearly twice the rate of core inflation over the past year, rising 1.8 percent compared to the core inflation rate of 1 percent for the year ending in January.

But that's nothing compared to fuel costs. "The big culprit has been energy prices, which are up 7.3 percent" over the same time frame, says Hampel.

"If food and energy are going up faster than 1 percent and everything not counting them is going up at a little less than 1 percent, that is how we get the overall inflation rate of 1.6 percent," he says.

Raw materials vs. the price consumers pay

If you're an average American consumer, as envisioned by the Bureau of Labor Statistics, about 15 percent of your total spending goes to food, including eating out. Food commodities account for only a fraction of that expenditure. Depending on your diet, the from-the-farm cost of food could account for less than 20 percent of your grocery bill.

Some food products, such as coffee, may rise more than the USDA's forecasted 4 percent.

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In the case of coffee beans, the market hit a 13-year high last summer and companies such as J.M. Smucker and Kraft Foods Inc. increased prices on brands Folgers, Dunkin' Donuts and Millstone. Green Mountain Coffee raised the price on some of their coffee brands by as much as 15 percent.

Prices have continued to increase. According to the International Coffee Organization, the main international coffee trade group, the ICO daily composite indicator price hit 222.89 cents per pound in early March. Back in September 2010, the average was 163.61 cents per pound. The highest price the ICO has on record was 326.50 cents per pound on April 14, 1977.

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