Financial Terms / C - D / Consumer Price Index (CPI)

What is the consumer price index (CPI)?

The Consumer Price Index (CPI) is a key measure of inflation in the United States. It tracks the monthly price change paid by U.S. consumers for a basket of goods and services. The Bureau of Labor Statistics (BLS) calculates the CPI as a weighted average, representing aggregate consumer spending.

The CPI is widely used and closely watched by policymakers, financial markets, businesses, and consumers. It's the most popular indicator of inflation and deflation, covering about 93% of the U.S. population.

To calculate the CPI, the BLS collects around 80,000 prices monthly from about 23,000 retail and service establishments. They weigh each product or service based on its share of recent consumer spending. The calculation also accounts for the substitution effect, as consumers shift spending away from products rising in price.

The CPI has a rich history. The BLS began collecting family expenditure data in 1917 and published its first price indexes for select cities in 1919. In 1921, they released a national CPI, including estimates back to 1913. These early methods are generally compatible with current practices, providing a consistent measure of price changes over time.

How is the CPI calculated?

The Consumer Price Index (CPI) calculation is a complex process involving data collection, weighting, and adjustments. The Bureau of Labor Statistics (BLS) starts by gathering price data for hundreds of goods and services, known as the "market basket." They collect this information from about 8,000 housing units and 23,000 retailers, service providers, and online outlets across 75 urban areas in the United States.

To determine which items to include and their importance in the index, the BLS uses the Consumer Expenditure Survey. This survey helps establish weights for dozens of categories, subcategories, and specific items in the CPI basket.

The CPI calculation happens in two main stages:

Elementary indices: The BLS estimates these for each elementary aggregate by collecting a sample of representative prices and calculating an average price change.
Weighted average: They then take a weighted average of the elementary indices using the expenditure shares of the elementary aggregates as weights.

The largest category in the CPI is shelter, accounting for nearly a third of the index. The most significant item, at about 22.3%, is "owner's equivalent rent of primary residence," which represents how much homeowners would pay if they were renting their homes.

Types of Consumer Price Indexes

The Bureau of Labor Statistics (BLS) calculates various types of Consumer Price Indexes to measure inflation for different population groups. The two main types are the CPI-U and CPI-W.

CPI-U (Urban Consumers)

The Consumer Price Index for All Urban Consumers (CPI-U) is the headline index. It tracks monthly price changes for a basket of goods and services used by urban consumers. The CPI-U covers about 93% of the U.S. population, making it the most comprehensive measure of consumer inflation.

CPI-W (Urban Wage Earners and Clerical Workers)

The CPI-W focuses on households where at least 50% of income comes from clerical or wage-paying jobs. It covers about 29-32% of the U.S. population, primarily blue-collar workers. The CPI-W is used to calculate cost-of-living adjustments (COLAs) for Social Security benefits.

Other Specialized Indexes

The BLS also produces other specialized indexes, including:

Chained CPI for All Urban Consumers
Sticky Price CPI
Flexible Price CPI
Trimmed Mean CPI

These indexes offer different perspectives on inflation, accounting for factors like consumer substitution behavior or price volatility.

Uses and applications of the CPI

The Consumer Price Index (CPI) has a significant impact on various aspects of the economy and personal finances. You'll find it used in several important ways:

Measuring inflation: The CPI is the most well-known indicator of inflation, showing the average change in prices over time for goods and services that households buy.
Economic policy decisions: The Federal Reserve uses CPI data to shape monetary policy. With a target inflation rate of 2%, the Fed may adjust its policies based on CPI readings.
Wage and benefit adjustments: Many workers have their wages tied to CPI changes. The Social Security Administration uses the CPI-W to determine cost-of-living adjustments (COLAs) for Social Security benefits.
Tax adjustments: The Internal Revenue Service (IRS) uses the CPI-U to adjust federal tax brackets and standard deduction amounts annually.
Minimum wage updates: After initial increases, annual adjustments to minimum wage rates are often based on CPI changes.

Understanding these applications helps you grasp the CPI's broad influence on economic decisions and personal finances.

FAQs

What does the Consumer Price Index (CPI) represent in simple terms?

The Consumer Price Index, or CPI, is a set of indexes that tracks the price changes urban consumers experience for a variety of goods and services. This includes a wide range of items such as food, vehicles, and housing costs. Essentially, it measures how the prices of a market basket of consumer goods and services change over time.

Is the Consumer Price Index the same as inflation?

Yes, the Consumer Price Index (CPI) is the most recognized indicator of inflation. It calculates the percentage change in the cost of a basket of goods and services that households commonly use.

What is the current rate of the Consumer Price Index?

As of the latest update, the US Consumer Price Index stands at 313.53, which is an increase from 313.05 the previous month and up from 304.63 a year ago. This represents a monthly change of 0.15% and an annual change of 2.92%.

What implications arise from an increase in the CPI?

An increase in the Consumer Price Index (CPI) suggests that the prices of consumer goods and services are rising, indicating higher inflation. Conversely, a decrease in the CPI suggests falling consumer prices, which could indicate lower inflation or deflation.