Question

During the financial crisis of 2008 -2009 CPI in the USA decreased dramatically. What can explain such a decrease? What elements of the CPI basket were affected by the crisis and why? How do you think the CPI will change in 2020?

Answer 1

During the financial crisis of 2008 -2009 CPI in the USA decreased dramatically. This was because of the recession where demand decreased dramatically due to which both the price and quantity decreased, resulting in lower expenditure by consumers (smaller market basket). The effect of decrease in demand on price and quantity is illustrated below:

When demand decreases, the demand curve shifts to the left, from D to D1, indicating a decrease in both price and quantity. Due to decreased price and quantity, the expenditure was lower in 2008-09, resulting in lower CPI in relation to the base year.

How do you think the CPI will change in 2020?

In the year 2020, the global economy is facing another unusual economic activity. Due to COVID - 19, spending pattern is once again diverted from the normal spending pattern. Essential consumables (water, toilet paper, tinned goods, computer and internet related goods for online work/school, etc.) and medicines (related to the virus in particular, and flu in general) have seen an unprecedented demand, thus increasing the quantity to very high level and also increasing the price. On the other hand, expenditure on luxury goods like real estate, holidays, travel of all sorts and automobiles has plummeted to a new low. Demand in general has decreased due to large scale deaths, unemployment and fear of the disease.

In other words, some area have seen very high demand, and some area have seen very low demand. As the market basket consists of both these types of goods, it is definite to make a mark. But the direction is yet to be known. If increase in one has offset the decrease in the other, CPI may not be very different than the normal growth. But if one has exceeded the other in leaps and bounds, then CPI may either show high (if spending on essentials has exceeded the non-spending on non-essentials) or low (if non-spending on non-essentials has exceeded the spending on essentials). However, the news in the media suggest the latter as people have been unemployed (laid off or even downgraded).  We will know soon.