Consumer Price Index (CPI)

What Is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking 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.

Understanding the Consumer Price Index (CPI)

Inflation is the decline of a given currency's purchasing power over time; or, alternatively, a general rise in prices. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.

The CPI is what is used to measure these average changes in prices over time that consumers pay for goods and services. Essentially, the index attempts to quantify the aggregate price level in an economy and thus measure the purchasing power of a country's unit of currency. The weighted average of the prices of goods and services that approximates an individual's consumption patterns is used to calculate CPI. A trimmed mean may be used as part of this calculation.

The U.S. Bureau of Labor Statistics (BLS) reports the CPI on a monthly basis and has calculated it as far back as 1913. It is based upon the index average for the period from 1982 through 1984 (inclusive), which was set to 100. So a CPI reading of 100 means that inflation is back to the level that it was in 1984, while readings of 175 and 225 would indicate a rise in the inflation level of 75% and 125% respectively. The quoted inflation rate is actually the change in the index from the prior period, whether it is monthly, quarterly, or yearly.

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 July 2021, the Consumer Price Index increased 0.5% from June to July, slower than the 0.9% month-over-month increase from May. When compared to the year prior, the full index increased 5.4%, making it the largest 12-month increase since 2008.

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, 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:

Investopedia / Maddy Price

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.

Calculating CPI 

The BLS records about 80,000 items each month by calling or visiting retail stores, service establishments (such as cable providers, airlines, and car and truck rental agencies), rental units, and doctor's offices across the country in order to get the best outlook for the CPI.

The formula used to calculate the Consumer Price Index for a single item is as follows:

CPI =  Cost of Market Basket in Given Year Cost of Market Basket in Base Year × 100 \text{CPI}=\frac{\text{ Cost of Market Basket in Given Year}}{\text{Cost of Market Basket in Base Year}}\times100 CPI=Cost of Market Basket in Base Year Cost of Market Basket in Given Year×100

The base year is determined by the BLS. CPI data for more recent years are based on surveys collected in earlier years.

Types of CPI

Two types of CPIs are reported each period:

1. 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 from 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 costs of benefits paid to those on Social Security. This measurement of CPI represents at least 28% of the country's population.
2. The CPI-U is the Consumer Price Index for All Urban Consumers. It accounts for 88% of the U.S. population and is the better representation of the general public. The BLS made improvements to 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:

1. Northeast
2. Midwest
3. South
4. West

Three major metro areas are also broken out each month:

1. Chicago-Naperville-Elgin, IL-IN-WI
2. Los Angeles-Long Beach-Anaheim, CA
3. 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.