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April 1996

Volume 2 Number 4

Core CPI: Excluding Food, Energy . . . and Used Cars?
Richard W. Peach and Karen Alvarez

Although used car prices represent only a small portion of the consumer price index, their
extreme volatility has had a major impact on the measured inflation rate. To explain this
relationship, the authors describe how used cars are treated in the CPI and explore what
might cause the wide swings in used car prices.

Traditionally, policymakers and financial markets have
regarded the “core” consumer price index (CPI) as a
key inflation indicator. The core CPI, a special index
published by the Bureau of Labor Statistics (BLS),
excludes the volatile prices of food and energy. In
excluding these components, BLS recognizes that
prices that swing dramatically in response to unusual
shifts in weather and other unforeseen events could
skew assessments of underlying inflation trends.

0.15 percentage point higher.2 For such a small component to have such a considerable influence on the CPI,
its price changes must be both large and volatile.
Indeed, monthly percentage changes in used car prices
went from an annual rate of 27 percent in March 1995
to -5 percent in June and then back to 10 percent in
January 1996.

In August 1995, the Congressional Budget Office
refined its analysis of inflation by adopting a separate
definition of core inflation: it excluded used cars in
addition to food and energy from the overall CPI.1 The
motive was once again to minimize the potentially distorting effects of unusually volatile prices. Over the
preceding year, wide swings in the rate of change of
used car prices had whipsawed the traditional measure
of core inflation.

What is behind this extreme price volatility? In this
edition of Current Issues, we discuss how used cars are
treated in the CPI and explore the causes of these wide
swings in the rate of change of used car prices. We contend that the used car component of the index is so
volatile because it is derived from wholesale auction
prices rather than retail transaction prices. Accordingly,
we believe that switching to retail transaction prices for
used cars would eliminate much of this volatility. Until
such a change is made, the traditional measure of core
inflation could remain vulnerable to serious distortions.

In 1995, used car prices represented only 1.32 percent of the CPI. Nonetheless, their impact on the
measured inflation rate has been substantial: core
inflation accelerated to 3.8 percent by March 1995 and
decelerated to around 2.8 percent by July (Chart 1).
However, when used cars are excluded, the level of core
inflation reached in March was nearly 0.3 percentage
point lower, while the level reached in July was about

Used Cars in the CPI
Conceptually, the CPI is intended to measure changes
in the price of goods and services of a constant quality.
Price increases attributed to improvements in quality
are not regarded as inflation, since the higher price
brings with it higher value or greater utility to the
consumer. Measuring pure price change for used cars is


BLS obtains the raw price data for this sample from
the Official Used Car Trade-In Guide, or “Blue Book,”
published by the National Automobile Dealers
Association (NADA). Each month, the Blue Book lists
average wholesale auction prices from roughly 170
dealer-only auctions held across the United States each
week.6 Prices are listed for a wide array of makes, models, and options, as well as for three broad categories of
overall condition—clean, average, and rough. BLS uses
prices from the clean category, the condition of most
cars coming out of the business and government fleets.7

a more complicated endeavor than for most other goods
and services because used cars depreciate over time. To
measure pure price change, BLS must estimate the rate
of depreciation and evaluate actual price movements
relative to that rate. In addition, the quality of cars has
been improving over time, complicating the estimation
of depreciation.
Defining and Pricing Used Cars in the CPI. The
CPI is a composite index, with price data for numerous
products and services assigned a weight representing
their relative importance in the typical consumer’s consumption expenditures. Used cars represent a relatively
small proportion of those expenditures and so are
assigned a relatively small weight (1.32 percent of the
CPI in 1995, or 1.71 percent of the core CPI). 3 As
defined by BLS, that weight reflects net consumer purchases of used cars—that is, used car imports and used
cars purchased by the consumer sector from the business and government sectors, plus car dealers’ profits
on sales of used cars. The weight does not reflect consumer purchases of used cars from other consumers,
even when a car dealer acts as intermediary, because
they are transfers of assets within the consumer sector,
which are not covered by the CPI.4

Measuring Depreciation and Improvements in
Quality. Inflation for used cars is determined by the
rate of change of these observed auction prices relative
to the rate of depreciation. If the rate of change of the
observed price is greater (less) than the rate of depreciation, the price on a constant-quality basis has
increased (fallen).
BLS estimates the rate of depreciation as the percentage difference in price between consecutive vintages of
the same model. For example, if in March 1996 the average auction price of a 1994 Zebra XL was $10,000 while
the average auction price of a comparably equipped
1993 Zebra XL was $9,000, at that point in time the
1993 Zebra XL was depreciating at a rate of 10 percent
per year. If the observed price of the 1993 Zebra XL was
declining at a 7.5 percent annual rate, on a constantquality basis the price would actually have been rising.

Because the used cars sold by business and government fleets account for most of these net sales, they
form the universe from which BLS draws a sample of
350 combinations of make, model, and options.5 This
sample consists of models ranging in age from two to
six years, with the bulk between two and three years
old; the sample is updated for the new model year
between September and November.

BLS accounts for improvements in the quality of
used cars by modifying the procedure for estimating the
rate of depreciation.8 This modification begins with the
percentage increase in price attributed to improvements
in quality when the model was introduced as a new car.
For example, suppose that when the 1994 Zebra XL
was introduced, its manufacturer’s suggested retail
price (MSRP) was 10 percent above the MSRP of the
1993 Zebra XL when it was introduced. Suppose further that BLS attributed half of that price increase, or
5 percent, to improvements in quality. That percentage
quality adjustment is assumed to remain constant over
the entire period that the vehicle remains in the used car
sample. Under those assumptions, the estimated rate of
depreciation of the 1993 Zebra XL is half that of the
above example, or 5 percent. In that case, if the
observed price is declining at a 7.5 percent annual rate,
then on a constant-quality basis the price is actually

Chart 1

Core CPI with and without Used Cars
Three-Month Moving Average of the Monthly Percentage Change in Prices
at an Annual Rate

Core CPI


BLS divides quality improvements into two categories: innovations and upgrades of standard equipment, such as anti-lock braking systems, stainless steel
exhaust systems, more efficient engines, and more
durable paints; and equipment and modif ications
required to meet federally mandated safety, fuel effi-

Core CPI
used cars


Source: U.S. Department of Labor, Bureau of Labor Statistics.



ciency, and emissions standards. BLS has estimated that
on average the MSRP of 1996 models rose by $495 over
the 1995 models, of which $193—or 39 percent—was
attributed to quality improvements.9 Changes designed
to satisfy federal mandates represented $105—or
54 percent—of the total quality improvements.10

increased at a faster rate than new car prices, rising by
36 percent compared with only 13 percent for new cars
(Chart 2).
These price trends indicate that a fundamental shift
of consumer demand from new to used cars has been
under way for some time. Additional evidence is provided by per capita sales of used light vehicles (autos
and light trucks), which have been rising over the past
two decades while per capita sales of new light vehicles
have been falling (Chart 3).12 Indeed, market research
has revealed an increased willingness to purchase a
used vehicle, particularly among luxury car buyers.13
Purchasing a two- or three-year-old car is a way of
moving up a notch or two in the car market for the same
monthly payments as a lower grade new car.

As the BLS estimates suggest, the portion of price
increases attributed to quality improvements tends to be
substantial. It can reasonably be argued that the adjustments BLS makes to prices of both new and used cars
overstate quality improvements and, therefore, understate the true rate of inflation. As noted earlier, the CPI
is intended to measure the change in price of goods and
services that provide the typical consumer a constant
level of utility. Although federally mandated safety,
fuel efficiency, and emissions standards benefit society
as a whole, the amount of additional utility they provide
to individual consumers is uncertain.11

Numerous other factors have contributed to this fundamental shift in consumer behavior:
Durability. Cars and light trucks built in recent years
are generally regarded as more durable and reliable
than those produced a decade ago. Automobile survival
rates have been steadily rising and warranties on new
vehicles have gotten longer and more comprehensive.14
These developments have reduced the risk of purchasing a used vehicle.

Trends in the Used Car Market
Clearly, measuring pure price change for used cars is a
complex endeavor. But what makes the rate of change
of used car prices so volatile? To answer that question,
we examine recent trends in the used car market. We
find that there has been dramatic growth in demand
over the past decade. As we will see, this growth in
demand has contributed to fundamental changes in the
underlying institutional setting of the supply side of the
used car market. We suspect that these changes have
resulted in greater volatility in wholesale auction prices
for used cars.

Affordability. It is often argued that new cars are less
affordable now than in the past. But the truth of this
claim depends on how one measures affordability. The
typical purchase price of a new car has risen substantially more than median family income over the past
two decades. The monthly principal and interest payments on the loans to finance these purchases, however,

Price and Sales Volume. The performance of car
prices suggests that in recent years the demand for used
cars has strengthened relative to supply. Since the
1990-91 recession, used car prices have consistently

Chart 3

New and Used Light Vehicle Sales
Units per capita

Chart 2

New cars

Levels of New and Used Car Prices

Index 1987=100
Used cars

New car trend





Used car trend

New cars

Used cars











94 95

Source: National Automobile Dealers Association.








Notes: Annual sales volumes are divided by the civilian noninstitutional
population aged sixteen and over. New car sales include retail and fleet
sales of autos and light trucks. Used car sales include retail and wholesale
sales by franchised new car dealers.

95 96

Source: U.S. Department of Labor, Bureau of Labor Statistics.



have been stable or declining as a percentage of median
family income because of an increase in the average
loan term from around thirty-six to nearly sixty months
(Chart 4). Loan-to-value ratios have also risen over the
past two decades, boosting monthly payments but
reducing the amount of cash needed upon purchase.15
One thing is clear: the longer terms and higher loan-tovalue ratios have reduced the amount of equity that the
typical car owner has in his or her vehicle. This development in turn has contributed to the rise of leasing and
the increase in used car sales.

paying a fair price. In addition, many financial planners
advise their clients to purchase a two- or three-year-old
car to avoid the rapid depreciation that occurs during
the first few years of a new car’s life.18
Explaining Used Car Price Volatility
The long-run rise in demand undoubtedly helps to
account for much of the rapid increase in used car
prices relative to new car prices. We contend that this
same phenomenon has been associated with changes in
the institutional setting of the used car market. These
changes have given the wholesale auctions, the basis of
used car prices in the CPI, more of the qualities of a
spot commodity market, where prices often move
sharply in response to imbalances in producers’ inventories of raw materials. Indeed, the rate of increase of
used car prices is roughly three times more volatile than
the rate of increase of new car prices (Chart 5).19

Leasing. Leasing has increased dramatically over
the past decade, resulting in a vast supply of relatively
low-mileage, late-model used cars. In 1994, leases represented one-third of retail deliveries of new cars, up
from about 12 percent a decade earlier.16 At the same
time, the average length of new car leases has declined,
while early terminations have increased. In many cases,
the original manufacturer’s warranty is still in effect on
vehicles returned to the lessor at the expiration of the
lease term (“off lease” vehicles).17

A decade or so ago, used car sales were dominated
by dealers who sold used cars exclusively; they were
not a major part of a typical new car dealer’s operation.
Aside from a few mint condition units, most cars taken
in trade by new car dealers were wholesaled to used car
dealers or sold at wholesale auctions. Because they
received most of the used cars they needed through
trade-ins, new car dealers were not very active on the
buy side of those auctions.

Information. Much more information on used vehicles is now readily available to consumers. For example,
in addition to publishing its Used Car Buying Guide,
Consumer Reports offers a 900 number through which
consumers can obtain current information on used car
prices, model reliability, and repair records. Armed
with such information, consumers are better able to
assess the relative value of the wide array of used cars
on the market and have greater confidence that they are

Over the past ten years, however, increased consumer demand for used cars has fundamentally changed
the used car market. Franchised new car dealers have
sought and captured much of the growth of the used car
market, typically selling more used cars than new ones
and earning greater profits from used car sales.20
Trade-ins and lease terminations are the source of

Chart 4

Principal and Interest Payments
for Typical New Car Purchase
Percentage of Median Family Income

Chart 5

New and Used Car Components of the CPI

Loan term
constant a


Twelve-Month Percentage Change


Used car





Loan term and
ratio constant b


New car








1975 76










Note: Payments reported are based on characteristics of loans made by
auto finance companies.

Constant at 1975 value of thirty-six months.


Constant at 1975 value of .865.



Source: Board of Governors of the Federal Reserve System.









95 96

Source: U.S. Department of Labor, Bureau of Labor Statistics.



roughly two-thirds of their retail used car sales. The
wholesale auctions remain a secondary source but now
account for roughly 25 percent of new car dealers’
greatly expanded retail used car sales volume.21

1. Congressional Budget Office (1995).
2. Prior to the revisions of the 1995 data, first published in February
1996, the effect of the used car component was nearly 0.50 percentage point in March 1995 and 0.25 percentage point in July 1995.

These proportions are, of course, averages. What is
most important for our argument is that their fluctuations over time can have pronounced effects on used car
prices. When sales of new cars are relatively strong,
the volume of trade-ins and off-lease cars coming onto
new car dealers’ used car lots increases. As a result,
new car dealers are likely increasing the volume of
vehicles sent to the wholesale auctions for sale. At the
same time, new car dealers are less aggressive bidders
on the demand side of those auctions because they need
fewer cars from this source. With increased supply and
decreased demand, the rate of increase of wholesale
auction prices tends to decelerate.

3. The CPI is a “fixed-weight” price index. Currently, weights for
each category of expenditure are based on consumer buying patterns in 1982-84.
4. See Kellar (1988).
5. Information on the universe of cars sold from the business and
government fleets is obtained from Runzheimer, a management
consulting firm located in Rochester, Wisconsin. The sample was
updated in April 1994.
6. For an interesting and thorough description of these auctions, see
Genesove (1993).

When sales of new cars fall, the process reverses:
dealers supply fewer used cars to the auctions while
becoming more aggressive bidders on the demand side
of the market. Thus, wholesale auction prices exhibit
much greater volatility than the retail transaction prices
of those vehicles because they are influenced by temporary imbalances in dealers’ inventories of used cars.

7. According to the National Automobile Dealers Association, the
Blue Book price data control for mileage. This adjustment is important because as leasing has grown as a share of retail deliveries of
new cars, the typical mileage of two- and three-year-old cars sold at
these auctions has declined.

In light of the considerable volatility of the wholesale auction prices, we believe that BLS might want to
explore our hypothesis by collecting data on actual
retail transaction prices of used cars from new car dealers. Although BLS already gathers data on retail transaction prices of new cars from those dealers, collecting
the used car data would no doubt add to the cost of
compiling the CPI. But if our hypothesis is correct,
using retail transaction prices would reduce the volatility of the used car component of the CPI, making the
traditional measure of core inflation a more reliable

9. The change in the MSRP cannot be expressed in percentage
terms because, as a general practice, BLS does not disclose the
average MSRP of the sample of new cars on which the quality
adjustment estimates are based. One reason cited is that the sample
of models used for evaluating quality changes differs each year.

8. The current methodology was introduced in 1987. Previously,
used car prices were not quality-adjusted.

10. The decision to treat the manufacturer’s cost of equipment and
modifications required to meet federal safety, fuel efficiency, and
emissions standards as improvements in quality rather than
increases in price was made by the Office of Management and
Budget in 1971.
11. For additional discussion, see Gordon (1990) and Pollak (1989).
12. The new vehicle sales series includes fleet sales and retail deliveries. Although a fleet sale is recorded when a car leaves the factory
floor and may be delivered directly to the fleet customer, such sales
are officially recorded as a sale of a franchised new car dealer. The
used vehicle sales series includes both retail and wholesale sales of
used vehicles by franchised new car dealers. The inclusion of the
wholesale sales does not result in serious double counting; it is a
proxy for the retail sales of dealers who sell used cars exclusively.

By explaining how BLS derives the used car component of the CPI, our discussion highlights just some of
the practical problems faced by those charged with
constructing an index to measure pure price change. In
the case of used cars, this is a particularly daunting task
since observed used car prices must be adjusted for
both depreciation and improvements in quality. We also
demonstrate how the extreme volatility of the used car
component has skewed the traditional measure of core
inflation, introducing a potentially serious distortion to
a widely followed gauge of inflation trends in the U.S.
economy. However, we believe that the collection of
actual retail transaction prices of used cars—rather
than the use of wholesale auction prices—would significantly dampen that volatility.

13. “Driven Only on Sunday” (1995).
14. The survival rate is the percentage of a model-year fleet still in
operation after a specified number of years. For example, NADA
reports that 60 percent of all 1979 models were still in operation
after twelve years, compared with 40 percent of 1966 models. Of
course, this result could be influenced by economic as well as technical factors.
15. The purchase price and financing terms presented are for new
car purchases financed by the auto finance subsidiaries of the big
three domestic auto manufacturers (Chrysler, Ford, and General




16. CNW Marketing Research, Bandon, Oregon.
17. Although increased leasing has contributed to the long-term
increase in used car sales, higher used car prices have fueled the
move toward leasing. One of the key variables determining the
monthly lease payments is the assumed residual value of the vehicle at the end of the lease period. The rapid rise of used car prices
has allowed lessors to be fairly aggressive in their projections of
residual value, thus reducing monthly payments.
18. Wood (1994) found that contrary to popular opinion, in percentage terms the loss in value that a car undergoes after it is driven off
a dealer’s lot increases with the car’s age.
19. Between January 1988 and January 1996, there is no statistically significant trend in the twelve-month percentage change of
either the new or the used car component of the CPI. The ratio of
the standard error of the twelve-month percentage change over the
mean twelve-month percentage change is 1.06 for used cars, compared with 0.37 for new cars.
20. NADA (1993).
21. NADA (1995).

Congressional Budget Office. 1995. “The Economic and Budget
Outlook: An Update.” August.
“Driven Only on Sunday.” Fortune, June 26, 1995.
Genesove, David. 1993. “Adverse Selection in the Wholesale Used
Car Market.” Journal of Political Economy 101, no. 4: 644-65.
Gordon, Robert J. 1990. The Measurement of Durable Goods
Prices. Chicago: University of Chicago Press.
Kellar, Jeffrey H. 1988. “New Methodology Reduces Importance of
Used Cars in the Revised CPI.” Monthly Labor Review 111,
no. 12: 34-6.
National Automobile Dealers Association (NADA). 1993. “Project
2000: The Future of the Retail Auto Industry.” July.
__________. 1995. “NADA Data: 1995.” August.
Pollak, Robert A. 1989. The Theory of the Cost-of-Living Index.
New York: Oxford University Press.
Wood, William C. 1994. “The Cost of Driving a Car Off the Dealer’s
Lot.” The Journal of Consumer Affairs 28, no. 1: 130-36.

The authors would like to thank Tim LaFleur, Tod Reese, and Liz Spear of the Bureau of Labor Statistics for their comments on an earlier draft of
this article and Art Spinella of CNW Marketing Research for information on light vehicle leasing.

About the Authors
Richard W. Peach is a research officer and senior economist in the Business Conditions Function of the
Research and Market Analysis Group. Karen Alvarez is an assistant economist in the Domestic Research

The views expressed in this article are those of the authors and do not necessarily reflect the position of
the Federal Reserve Bank of New York or the Federal Reserve System.

Current Issues in Economics and Finance is published by the Research and Market Analysis Group of the Federal
Reserve Bank of New York. Dorothy Meadow Sobol is the editor.
Editorial Staff: Valerie LaPorte, Mike De Mott, Elizabeth Miranda
Production: Graphics and Publications Staff
Subscriptions to Current Issues are free. Write to the Public Information Department, Federal Reserve Bank of
New York, 33 Liberty Street, New York, N.Y. 10045-0001, or call 212-720-6134. Back issues are also available.