What is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) measures the monthly change in prices paid by U.S. consumers. The Bureau of Labor Statistics (BLS) calculates the CPI as a weighted average of prices for a basket of goods and services representative of aggregate U.S. consumer spending.
The CPI is one of the most popular measures of inflation and deflation. Unlike the producer price index (PPI), which measures changes in the prices received by U.S. producers, the CPI measures changes in the costs experienced by consumers.
Key Highlights
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Measurement Tool: The CPI measures the overall change in consumer prices over time based on a representative basket of goods and services.
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Inflation Tracker: The CPI is the most widely used gauge of inflation, monitored closely by policymakers, financial markets, businesses, and consumers.
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Population Coverage: The extensively quoted CPI covers 93% of the U.S. population, though there are variations that cover wage earners and clerical workers for specific applications like cost-of-living adjustments to federal benefits.
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Data Collection: Monthly, about 80,000 price quotes are collected from 23,000 retail and service establishments and 50,000 rental housing units.
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Housing Costs: Housing rents are used to estimate the change in shelter costs, which include owner-occupied housing and account for about one-third of the CPI.
Understanding the Consumer Price Index (CPI)
The BLS collects approximately 80,000 prices each month from around 23,000 retail and service establishments. Although both major CPI indexes include the term “urban,” the more broadly cited index covers a substantial 93% of the U.S. population.
Prices in the shelter category, comprising about a third of the overall CPI, are determined by surveying rental prices for 50,000 housing units. This survey also calculates changes for owners’ equivalents, modeling rent equivalents for owner-occupied housing to accurately reflect the cost relative to consumer spending.
The CPI calculation does include user fees, sales, or excise taxes but omits income taxes and investments like stocks, bonds, or insurance policies.
Types of CPIs
The BLS publishes two indexes monthly:
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Consumer Price Index for All Urban Consumers (CPI-U): Represents 93% of the U.S. population, excluding residents in rural areas and special groups. This index is the basis for the most widely reported inflation numbers.
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Consumer Price Index for Urban-Wage Earners and Clerical Workers (CPI-W): Covers 29% of the population, mainly households with income from clerical or hourly wage jobs. This index is used to adjust Social Security payments and other federal benefits.
CPI Formulas
Two main formulas are used for CPI calculations:
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Annual CPI Formula:
Annual CPI = (\frac{\text{Value of Basket in Current Year}}{\text{Value of Basket in Prior Year}}) × 100
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Inflation Rate Formula:
Inflation Rate = (\frac{\text{New CPI} - \text{Prior CPI}}{\text{Prior CPI}}) \times 100
How is the CPI Used?
Federal Reserve
The Federal Reserve uses CPI data to develop economic policies. With an inflation target of 2%, the Fed may adjust its monetary policy to bring the economy back within desired parameters.
Government Agencies
The cost-of-living adjustments (COLAs), impacting Social Security and other federal benefits, rely on the CPI. These adjustments influence pay structures and ensure harmonious economic governance.
Housing
The CPI helps adjust mortgage rates and other long-term debt forms. Landlords also use CPI data to determine annual rent increases.
Financial Markets
The CPI influences financial markets by predicting governmental policies. Higher CPI may lead to a lenient monetary stance, whereas lower CPI may see policies that aim to reinvigorate the economy.
Labor Markets
Labor negotiations, wage setting, and other employment agreements often use the CPI to take account of changes in the economic climate.
CPI vs. Unemployment
Generally, the CPI and unemployment rates are inversely related, although this isn’t always the case. For example, during the COVID-19 pandemic, efforts to boost the economy saw reduced unemployment but an increase in CPI.
Criticism of CPI Methodology
The CPI often draws empirical scrutiny, with some arguing it overstates or understates inflation. For instance, adjustments for product quality can induce disputes. Conversely, the CPI’s traditional computation methods may miss specific impacts felt by varied demographics.
Conclusion
The Consumer Price Index is pivotal in illustrating average price changes paid by consumers, indicating the broader economic landscape. Not only does it serve as a crucial gauge for inflation, but it also has essential applications in personal income adjustments and governmental policy formulations.
Monitoring these changes assists in maintaining economic stability, ensuring that various facilitating decisions remain well-grounded.
Related Terms: inflation, deflation, Federal Reserve, cost of living, economic indicators.
References
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”, Select How and when are CPI prices collected and reviewed?
- U.S. Bureau of Labor Statistics. “Consumer Price Indexes Overview”.
- U.S. Bureau of Labor Statistics. “Measuring Price Change in the CPI: Rent and Rental Equivalence”.
- U.S. Bureau of Labor Statistics. “Frequently Asked Questions about the Chained Consumer Price Index for All Urban Consumers (C-CPI-U)”, Select What is substitution and substitution bias? And does the C-CPI-U eliminate it?
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”, Select Is the CPI a cost-of-living index?
- U.S. Bureau of Labor Statistics. “CONSUMER PRICE INDEX”.
- Social Security Administration. “Cost-of-Living Adjustment (COLA) Information”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”, Select What goods and services does the CPI cover?
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”, Select What area indexes are published and how often?
- U.S. Bureau of Labor Statistics. “CONSUMER PRICE INDEX”, Page 8.
- Board of Governors of the Federal Reserve System. “FAQs: Why Does the Federal Reserve Aim for Inflation of 2 Percent Over the Longer Run?”
- U.S. Bureau of Labor Statistics. “How to Use the Consumer Price Index for Escalation”.
- The White House. “Housing Prices and Inflation”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions”, Select How is the CPI used?
- U.S. Bureau of Labor Statistics. “Schedule of Releases for the Consumer Price Index”.
- Board of Governors of the Federal Reserve System. “Coronavirus Disease 2019 (COVID-19): Supervisory and Regulatory Actions in Response to COVID-19”.
- Federal Reserve Bank of St. Louis, FRED Economic Data. “Unemployment Rate”.
- Federal Reserve Bank of St. Louis, FRED Economic Data. “Federal Funds Effective Rate”.
- Social Security Administration. “Reports & Studies Archive: The Boskin Commission Report”.
- U.S. Bureau of Labor Statistics. “Consumer Price Index Data Quality: How Accurate Is the U.S. CPI?”
