The Consumer Price Index (CPI) is a monthly measure of how the aggregate costs of consumer goods and services in the United States are changing. Economists use CPI to help them understand whether the economy is in a period of inflation or deflation, and individuals can use it to get a sense of where prices might be headed.
What Is the Consumer Price Index (CPI)?
The CPI measures the change of the weighted-average prices paid by urban consumers for select goods and services, according to the Bureau of Labor Statistics (BLS). In other words, the metric tracks the rise and fall of prices over a given period of time.
Definition and Significance
As mentioned, “CPI” is short for Consumer Price Index, and it’s an often-cited economic indicator.
The BLS produces indexes that cover two populations: CPI-U covers all urban consumers, representing more than 90% of the population. And CPI-W represents urban wage earners and clerical workers, representing approximately 30% of the population. The CPI excludes people who live in rural areas, the military, and imprisoned people.
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How the CPI Works
The CPI tracks prices for a basket of goods and services people commonly buy in eight major categories, including:
• Food and beverage
• Recreation
• Apparel
• Transportation
• Housing
• Medical care
• Education and communication
• Various services
CPI Formulas
Each month, the BLS contacts retailers, service providers, and rental spaces across the country gathering prices for about 80,000 items. It uses this data to calculate CPI using the following formula:
CPI = Cost of the Market Basket in a Given Year/Cost of the Market Basket in the Base Year.
The result is multiplied by 100 to express CPI as a percentage. The BLS uses the years 1982-1984 as its base year. It set the index level during this period at 100.
Annual CPI Calculation
Here’s an example of the annual CPI calculation, and comparing two different years to get a gist of the differences.
Imagine the cost of a hypothetical basket of goods in 1984.
| Sweatshirt | 1 dozen eggs | Movie ticket | |
|---|---|---|---|
| Price in 1984 | $10 | $1.50 | $5 |
| Quantity | 2 | 6 | 10 |
| Total Cost | $20 | $9 | $50 |
When you total the price of these goods you get $79. Using the CPI formula above you take $79/$79 x 100 = 100%. This is where the 1984 base rate of 100 comes from.
Now let’s consider the same basket of goods in 2023.
| Sweatshirt | 1 dozen eggs | Movie ticket | |
|---|---|---|---|
| Price in 2023 | $24 | $3 | $15 |
| Quantity | 2 | 6 | 10 |
| Total Cost | $48 | $18 | $150 |
When you total the prices of these goods you get $216. Now, when you plug this into the CPI formula you get $216/$79 x 100 = 273%. You can now tell that from 1984 to 2023 prices for this particular basket of goods have risen by 173%.
Diverse Categories Within CPI
The CPI tracks more than 200 categories of items, and within each category it samples hundreds of specific items at various businesses which serve to represent the thousands of items available to consumers. In addition to these categories, CPI includes government-charged user fees like water, sewages, tolls, and auto registration fees. It also factors in taxes associated with the price of goods such as sales tax and excise tax. However, it does not include Social Security taxes or income taxes that aren’t directly related to the purchasing of goods and services.
The CPI also does not include the purchase of investments, like stocks and bonds.
The Consumer Price Index (CPI) in Practice
The CPI can be used in a variety of ways, but perhaps most prominently, in economic policy.
Usage in Economic Policy
The CPI is the most common way to measure inflation, the economic trend of rising prices over time, or deflation, the trend of falling prices. The federal government — or the Federal Reserve, more specifically — sets a target inflation rate of 2% annually, and the CPI can help the government understand whether or not its monetary policy is effective in meeting this target.
Recommended: What Is Deflation and Why Does It Matter?
The Federal Reserve’s Utilization
The Federal Reserve may look at the CPI to gauge whether or not to raise interest rates, which may cool or heat up the economy, accordingly, by increasing the cost of borrowing. As borrowing costs go up, demand for goods or services tends to fall, lowering prices, and putting downward pressure on the CPI.
Implications for Other Government Agencies
Economists also use CPI as a measure of cost of living, the amount of money you need to cover basic expenses, such as housing, food, and health care. This is important because the government may make cost-of-living adjustments to programs such as Social Security benefits. As the cost of living rises, benefit amounts may be adjusted higher to keep up with the rising costs of goods.
Employers may also look at the cost of living to help them set competitive salaries and determine when to raise wages for employees.
Recommended: Cost of Living by State
CPI’s Influence on Market Sectors
The CPI can also have an influence on market sectors, like the housing markets, financial markets, and even labor markets. As noted, a lot of it is top-down — depending on how the Federal Reserve reads the CPI and decides to change interest rates, if at all.
Raising rates can temper demand in the housing market, as a mortgage can become more expensive. It can also slow down sales for all sorts of businesses, which is reflected in earnings reports and finally, in the stock market. That can then spill into the labor market, and potentially raise unemployment as companies look to cut costs.
All told, the CPI’s influence can run deep in an economy.
CPI Versus Other Economic Indicators
The CPI is only one of many economic indicators, as mentioned. Others include unemployment, and the Producer Price Index (PPI).
CPI vs Unemployment: Understanding the Relationship
As noted, there tends to be a relationship between the CPI and unemployment rate, as the Fed targets 2% inflation, and full employment. As such, it can decide to make changes to monetary policy to try and restore balance or at least get closer to its goals.
CPI vs PPI (Producer Price Index)
The Producer Price Index or PPI measures the average change over time in the selling prices received by domestic producers of goods and services. In simpler terms, this metric measures wholesale prices for the sectors of the economy that produce goods. Like the CPI, the PPI can help analysts estimate inflation, as higher prices will show up on the wholesale level first before they get passed on to consumers at the retail level.
Analyzing and Critiquing the CPI Methodology
The CPI is a useful measure in many ways, but it does have some limitations. First, it doesn’t apply to all populations in the United States. CPI considers urban populations alone, so it is not necessarily representative of the costs for those who live outside of those areas.
Also, the CPI calculation does not take into account all of the goods and services available to consumers or new technologies not yet considered consumer staples. What’s more, the metric does not provide any contact into what’s causing prices to move up and down, such as social or environmental trends.
CPI’s Broader Impact and Usage
CPI reports are issued monthly by the BLS, and are available to anyone who wants to access them online. They give a broad breakdown of the previous month, and compare price changes year-over-year, and month-over-month.
Breaking Down the Monthly CPI Report
The standard CPI report has an introduction that discusses the changes over the previous month, followed by a table that outlines changes in specific price categories over the past year and several months. It further breaks down food, energy, and “all items less food and energy,” providing additional insight for each category.
Anticipating the Next CPI Report
The BLS publishes the date and time of the upcoming CPI report on its website, typically the second week of the month, at 8:30am ET.
Contemporary Relevance of CPI
In recent years, many people have kept a closely-trained eye on the CPI and CPI reports due to increased costs following the pandemic in 2020. While there were a variety of reasons as to why prices increased, that bout of inflation — the first serious case of inflation since the 1980s — caught many people off guard, and strained consumers’ budgets.
It also led to the Fed increasing interest rates. Inflation, or the increase in the CPI over the past couple of years, peaked at more than 9% during the summer of 2022, and as of late 2023, was back down to around 3.1%.
Educational Resources and Further Reading on CPI
There are numerous resources and places to learn more about the CPI, especially after all the attention it has garnered in recent years.
Learning More About CPI
A simple internet search will net a cornucopia of results, loaded with information and insight into the CPI. You’re also likely to find opinion pieces and other media discussing the CPI’s shortcomings or strengths — it can be a good idea to consider everything, and formulate your own opinion.
But in terms of learning more about the CPI itself, the BLS publishes a handbook discussing the concepts and methods it uses, which can also be helpful if you’re hoping to bolster your CPI IQ.
CPI-Related Statistics and Where to Find Them
The BLS publishes the CPI, and a whole host of data and statistics related to it. With that in mind, it can be a great place to start when hunting down CPI-related data. There are multiple other sources that utilize the BLS’ data to compile charts, graphs, and more, but typically, it’s all sourced back to the BLS.
The Bottom Line: Why the CPI Matters to Everyone
Rising inflation decreases the value of individuals’ cash savings over time. Investing in stocks, bonds and other investments that offer inflation-beating returns may help consumers protect the value of their savings. Understanding CPI, and how it’s moving, can help you devise a strategy for your investment portfolio.
The CPI can be a deep topic, especially when you consider how it intersects and relates to other elements of the economy, such as unemployment and interest rates. And again, the more an investor understands about the underlying machinations of the economy, the more knowledge they’ll have to power their decisions in the market.
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