Takeaways
- The CPI is one of the most widely used indicators to measure inflation.
- Consumers, businesses, politicians, and regulators closely watch the CPI.
- The CPI is often called the cost-of-living index because it reflects broad-based price changes.
- Many items, such as contracted wage and benefit adjustments, are pegged to the CPI.
- The CPI is calculated monthly based on thousands of data points from retailers, service providers, landlords, and consumers
What is the CPI?
The Consumer Price Index (CPI) is a monthly measurement of the changes in the prices of goods and services paid by U.S. consumers. The Bureau of Labor Statistics calculates the CPI and produces geographic-specific indexes. The CPI measures the average change over time for a “market basket” of consumer goods and services [1].
The Bureau of Labor Statistics collects data from over 23,000 retailers and service providers in 75 areas throughout the U.S. The rent calculation is sourced from approximately 50,000 tenants and landlords. Data is collected throughout the month to calculate a monthly CPI number used by investors, executives, and retail consumers to make purchase and investment decisions.
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How is the CPI Calculated?
Prices are collected throughout the month using statistical measuring techniques. For example, the primary form of data collection for goods and services comes from telephone calls, web collection, and even personal visits from BLS representatives. This data is collected to determine the current cost of a weighted average basket of products and services and analyzes year-over-year changes.
Consumer spending patterns are also considered when calculating the CPI. For example, service and product categories are weighted based on consumer spending from Consumer Expenditure Surveys [2].
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CPI is reported as a whole number, usually greater than 100. The Bureau of Labor Statistics then calculated the inflation rate from the prior year’s CPI, which is distributed in a public monthly economic news release.
Smart Tip:
In August 2023, the CPI-U increased by 3.7% for the 12 months ending August [3].
Types of CPI Indexes
The Bureau of Labor Statistics publishes thousands of consumer price indexes. However, there are two main CPI indexes often cited by financial media.
All Items Consumer Price Index for All Urban Consumers (CPI-U): This is considered the broadest and most used CPI number. This is what financial media use when they refer to inflation numbers. The CPI-U represents over 90% of the U.S. population.
The CPI-U is derived from the spending patterns of people living in metropolitan and urban areas. You can think of these as working professionals, self-employed, and retirees. The report excludes farm households, military families, and people living in remote rural areas.
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Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W): This monthly reported CPI number is comprised of workers with hourly wages and clerical employment. The CPI-W covers approximately 29% of the U.S. population living in households with clerical or hourly workers.
Consumer Price Index Categories
The Bureau of Labor Statistics categorizes all expenditure items used in the CPI into eight major groups. Under the umbrella of these groups, there are over 200 categories. The eight major groups are:
| Category | Expense Examples | Weight |
| Food & Beverage | Breakfast cereal, milk, coffee, chicken, wine, full-service meals, snacks | 14.38% |
| Housing | Rent of primary residence, owners' equivalent rent, utilities, bedroom furniture | 44.38% |
| Apparel | Men's shirts and sweaters, women's dresses, baby clothes, shoes, jewelry | 2.48% |
| Transportation | New vehicles, airline fares, gasoline, motor vehicle insurance | 16.75% |
| Medical Care | Prescription drugs, medical equipment and supplies, physicians' services, eyeglasses and eye care, hospital services | 8.11% |
| Recreation | Televisions, toys, pets and pet products, sports equipment, park and museum admissions | 5.39% |
| Education & Comm | College tuition, postage, telephone services, computer software and accessories | 5.85% |
| Other Goods & Services | Tobacco and smoking products, haircuts and other personal services, funeral expenses | 2.68% |
Source: Bureau of Labor Statistics [4]
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The CPI uses all direct costs associated with the purchase of goods in these categories, including sales and excise taxes. When calculating the monthly CPI numbers, the BLS uses scientific statistical procedures to determine the validity of their sampling size.
Who Uses the CPI?
Business executives use the CPI to make economic decisions. The CPI is a lagging indicator of inflation, so consumers use the CPI to make personal finance decisions, such as when to make big purchases. The CPI is also used to adjust for price and income changes. Inflation-adjusted payments use the CPI as a barometer. Collective bargaining agreements also use the CPI to tie wage increases to contract negotiations. Landlords use the CPI to adjust rent payments.
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Criticisms of the CPI
Many businesses and households use the CPI to determine purchasing and investment decisions, and scrutiny of the CPI calculation is high. The CPI is often criticized for its calculation methodology.
The CPI also does not help in measuring inflation for age-based cohorts. For example, college education disproportionally affects younger people, while prescription drug costs are associated with heavier use in older populations. However, they are both bundled in the same CPI calculation. Additionally, the CPI-U calculates inflation in urban and metropolitan areas and is not a good indicator for rural areas.
Smart Summary
The CPI is one of the most widely used indicators of inflation. The CPI aims to measure the changes in prices you face on a monthly and yearly basis. Although the CPI is a lagging indicator, it helps households and businesses make investment and purchase decisions. The CPI is a closely watched indicator because of its ramifications on all sectors of the U.S. economy. Keeping a pulse on the CPI will help you make better financial decisions.
Frequently Asked Questions
Seasonally adjusted changes include holidays, production cycles, and weather events that can distort numbers. Seasonally adjusting the numbers smooths out the data and eliminates the abrupt changes that happen at the same time and magnitude each year. Seasonally adjusted numbers help for relative comparison.
Businesses use the CPI to help to make compensation adjustments. For example, if the CPI is rising quickly and overall inflation is high, a business may need to increase employee compensation to keep top talent.
The CPI is a lagging indicator of economic policy. A lower CPI means that the Federal Reserve or other government policies have attempted to constrict growth. This may mean that policies may be easier to spur economic growth in the future.
[1] Bureau of Labor Statistics. Consumer Price Index. Last accessed September 18, 2023.
[2] Bureau of Labor Statistics. Frequently Asked Questions about the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). Last accessed September 18, 2023.
[3] Bureau of Labor Statistics. Consumer Price Index Summary. Last accessed September 18, 2023.
[4] Bureau of Labor Statistics. Relative importance of components in the Consumer Price Indexes: U.S. city average, December 2022. Last accessed September 18, 2023.
