What is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a measure that examines the weighted average price of a basket of consumer goods and services, such as transportation, food, and medical care.
It is calculated by taking the price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.
The CPI is one of the most frequently used statistics for identifying periods of inflation or deflation. It may be compared with the producer price index (PPI), which instead of considering prices paid by consumers, looks at what businesses pay for inputs.
- The Consumer Price Index measures the average change in prices over time that consumers pay for a basket of goods and services.
- It is the most widely used measure of inflation.
- The CPI statistics cover a variety of individuals with different incomes, including retirees, but does not include certain populations, such as patients of mental hospitals.
- The CPI is composed of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) and the Consumer Price Index for All Urban Consumers (CPI-U).
Understanding the Consumer Price Index (CPI)
Inflation is defined as a decrease in a currency’s purchasing power over time or a general increase in prices. The increase in the average price level of a basket of selected goods and services in an economy over time can be used to calculate a quantitative estimate of the rate at which buying power declines.
A rise in the general level of prices, which is frequently stated as a percentage, signifies that a unit of currency now buys less than it did previously.
The Consumer Price Index (CPI) is used to track the average changes in prices that consumers pay for products and services over time. Essentially, the index aims to quantify an economy’s aggregate price level.
The CPI is calculated using a weighted average of the prices of goods and services that approximates an individual’s consumption patterns. This calculation may include the use of a trimmed mean.
The CPI is calculated by the United States Bureau of Labor Statistics (BLS) on a monthly basis and has been calculated since 1913. It was calculated using a 100-point index average for the years 1982 to 1984 (inclusive).
A CPI number of 100 indicates that inflation has returned to its 1984 level, while readings of 175 and 225 imply a 75 percent and 125 percent increase in inflation, respectively. The quoted inflation rate is the change in the index from the previous year.
Though it does measure the variation in price for retail goods and other items paid by consumers, the Consumer Price Index does not include things like savings and investments and can often exclude spending by foreign visitors.
In December 2021, the Consumer Price Index increased 0.5% from November. Over the last 12 months, the full index increased 7%, the largest increase since the period ending June 1982.
How Is CPI Used?
CPI is an economic indicator. It is the most widely used measure of inflation and, by proxy, of the effectiveness of the government’s economic policy. The CPI gives the government, businesses, and citizens an idea about price changes in the economy and can act as a guide in order to make informed decisions about the economy.
The CPI and the components that make it up can also be used as a deflator for other economic indicators, including retail sales and hourly/weekly earnings.
Additionally, it can be used to value a consumer’s dollar to find its purchasing power. Generally, the dollar’s purchasing power declines when the aggregate price level increases and vice versa.
The index can also be used to adjust people’s eligibility levels for certain types of government assistance, including Social Security, and it automatically provides the cost-of-living wage adjustments to domestic workers.
According to the BLS, the cost-of-living adjustments of more than 50 million people on Social Security as well as military and federal civil services retirees are linked to the CPI.
Who and What Are Covered in the CPI?
The CPI statistics cover professionals, self-employed and unemployed people, people whose incomes are below the federal poverty threshold, and retired people. People not included in the report are non-metro or rural populations, farm families, the armed forces, people currently incarcerated, and those in mental hospitals.
The CPI represents the cost of a basket of goods and services across the country on a monthly basis. Those goods and services are broken down into eight major groups:
The BLS includes sales and excise taxes in the CPI—or those that are directly associated with the price of consumer goods and services—but excludes others that aren’t linked, such as income and Social Security taxes.
It also excludes investments (stocks, bonds, etc.), life insurance, real estate, and other items unrelated to consumers’ day-to-day consumption.
Types of CPI
Two types of CPIs are reported each period:
- The CPI-W is the Consumer Price Index for Urban Wage Earners and Clerical Workers. Between 1913 and 1977, the BLS focused on measuring this type of CPI. It was based on households whose incomes were comprised of more than one-half of clerical or wage occupations, and in which at least one of the earners was employed for at least 37 weeks during the previous 12-month cycle. The CPI-W primarily reflects changes in the cost of benefits paid to those on Social Security. This measurement of CPI represents at least 28% of the country’s population.
- The CPI-U is the Consumer Price Index for All Urban Consumers. It accounts for 88% of the U.S. population and is a better representation of the general public. The BLS made improvements to the CPI in 1978 and introduced a broader target population. This type of CPI is based on the spending of almost all of the population that resides in urban or metropolitan areas and includes professionals, self-employed workers, those living below the poverty line, those who are unemployed, and retired people. It also includes urban wage earners and clerical workers.
Despite introducing the CPI-U in 1978, the BLS continued to take the traditional measure of the CPI-W. But since 1985, the main difference between the two indexes has been the expenditure weights assigned to item categories and geographic areas.
CPI Regional Data
The Bureau of Labor Statistics also breaks down the CPI by region. Each month, the report is broken out into the four major Census regions:
Three major metro areas are also broken out each month:
- Chicago-Naperville-Elgin, IL-IN-WI
- Los Angeles-Long Beach-Anaheim, CA
- New York-Newark-Jersey City, NY-NJ-PA
Along with the regional information provided each month, the Bureau of Labor Statistics also publishes reports for 20 additional metro areas every other month. These reports cover areas with large populations and represent a particular regional subset.
Critiques of CPI Methodology
For several years, there has been some controversy about whether the CPI overstates or understates inflation, how it is measured, and whether it is an appropriate proxy for inflation. One of the main reasons for this contention is that economists differ on how they believe inflation should be measured.
Over the years, the methodology used to calculate the CPI has undergone numerous revisions. According to the BLS, the changes removed the supposed biases that caused the CPI to overstate the inflation rate in the past.
The newer methodology takes into account changes in the quality of goods and substitution. Substitution, the change in purchases by consumers in response to price changes, changes the relative weighting of the goods in the basket.
The overall result tends to be a lower CPI. However, critics view the methodological changes and the switch from a COGI to a COLI as a purposeful manipulation that allows the U.S. government to report a lower CPI. Today, critics of the CPI argue that the understated inflation metric does not capture the true rise in prices felt by consumers.
How Is the Consumer Price Index (CPI) Used?
The CPI is a statistical measure prepared by the Bureau of Labor Statistics (BLS). It is one of the most commonly cited economic statistics and is widely used as a proxy for inflation.
Investors pay close attention to the CPI as an indicator of where the economy is headed, influencing price forecasts for inflation-sensitive assets such as bonds and commodities.
Among the general public, the CPI is often seen as a barometer of overall economic health, with most commentators preferring a low-to-moderate CPI in the 2% to 3% range.
How Is the CPI Calculated?
The CPI is the weighted-average price of a broad cross-section of goods and services. This collection of items often referred to as the CPI’s “basket” of goods, is intended to mimic the typical products and services purchased by American consumers.
Over the years, as the prices of those products rise due to inflation, this gradual increase is reflected in a rising CPI. In the media, the CPI is commonly referred to in terms of its percentage year-over-year change.
What Are Some Criticisms of the CPI?
Some have argued that the CPI fails to capture regional variations in prices as well as the different buying patterns of particular groups of Americans.
For example, Americans living in expensive areas such as New York City or San Francisco may exhibit significantly different spending patterns compared to those living in rural or suburban areas.
Another common criticism of the CPI is that it understates the rate of inflation by failing to adequately reflect certain types of expenditures.
For instance, the CPI includes out-of-pocket medical expenses but does not fully reflect the portion of medical expenses borne by insurance companies and government healthcare programs.