Dear Client:Washington, Feb. 20, 2009
 

                Look for consumer prices to rise more this year than last...
                A 1% increase in the Consumer Price Index (CPI) in 2009,
measuring from December to December, vs. a 0.1% gain last year.
                Excluding volatile food and energy prices...also up 1%.
The impact of the recession will keep the inflation outlook benign

amid a broad decline in demand for goods and services and lower energy prices.
Despite the CPI’s year over year rise in 2009, it will still be well below the 4.1% jump
recorded in 2007, when prices of oil, gasoline and many other commodities spiked.

                If anything, the risk to the economy is deflation...a cycle of falling prices.
Deflation, though uncommon, is not easily defeated. As prices drop across the board
on goods, services and wages, consumers and companies aren’t inclined to buy
because they are convinced prices will continue to decline. As the economy suffers,
other assets, including stocks and housing, are drawn in, making the distress worse.

                In fact, the Federal Reserve flagged the potential problem earlier this year,
letting investors know it is on alert even as it battles the recession and credit crisis.
The Fed would fight deflation by buying enough assets to change price perceptions
for the better. But it’s tricky. If the Fed goes too far, it can trigger an inflation surge.
                The Fed wants to avoid mistakes made by the Bank of Japan in the 1990s,
when it pumped massive, untargeted capital into markets. That wasn’t enough.
Japan’s economy stagnated for years. If the Fed has to fight deflation, it’ll buy assets,
such as 10-year Treasuries or bonds backed by commercial real estate. If necessary,
the Fed might buy corporate or municipal bonds to revive activity in those areas.

                But we're a long way from a small dose of inflation. Consumer prices rose
at a very low rate in 2008 because oil prices collapsed after surging early in the year.
Gasoline prices, for example, fell 43%, the biggest drop in 70 years. Apparel fell, too.
Some prices rose, though gains were modest in housing, recreation and medical care.

                The CPI is a measure of purchasing power...a hypothetical basket of goods
and services that a dollar can buy today compared with a set time period in the past.
                It is also a widely used benchmark for periodic adjustments of various fees
and payments, such as wage rates, property rents and other types of fees.

                Here’s how it’s calculated. In 87 cities, the Bureau of Labor Statistics
surveys 23,000 businesses. Each month, the agency tracks prices for 80,000 goods
and services and then measures them against a benchmark period, 1982 to 1984.
The items tracked are grouped into categories, such as nonprescription drugs,
dairy products, rent and footwear. Each group is weighted to reflect the expenditures
of the average consumer. For example, food at home is 8.1%; recreation is 5.2%.

                To figure out what inflation has done to your costs, consult our calculator
at kiplingerbiz.com/tools/inflation to see year over year price changes,
or see a chart at kiplinger.com/businessresource/economic_outlook/cpi/cpichart.pdf.
You can also send for a printed table of changes in the index going back to 1981.