Consumer Price Index
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. The CPI report uses a different survey methodology, price samples, and index weights than the producer price index (PPI), which measures changes in the prices received by U.S. producers of goods and services.
The BLS collects about 80,000 prices monthly from some 23,000 retail and service establishments. Although the two CPI indexes calculated from the data both contain the word urban, the more broad-based and widely cited of the two covers 93% of the U.S. population.
Shelter category prices accounting for a third of the overall CPI are based on a survey of rental prices for 50,000 housing units, which is then used to calculate the rise in rental prices as well as owners' equivalents.
The owners' equivalent category models the rent equivalent for owner-occupied housing to properly reflect housing costs' share of consumer spending.
User fees and sales or excise taxes are included, while income taxes and the prices of investments such as stocks, bonds, or life insurance policies are not part of the CPI.
The calculation of the CPI indexes from the data factors in substitution effects—consumers' tendency to shift spending away from products and categories has grown relatively more expensive. It also adjusts price data for changes in product quality and features. The weighting of the product and service categories in the CPI indexes corresponds to recent consumer spending patterns derived from a separate survey.
Variation of CPI
The BLS publishes two indexes each month. The Consumer Price Index for All Urban Consumers (CPI-U) represents 93% of the U.S. population not living in remote rural areas. It doesn't cover spending by people living in farm households, institutions, or on military bases. CPI-U is the basis of the widely reported CPI numbers that matter to financial markets.
The BLS also publishes the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W covers 29% of the U.S. population living in households with income derived predominantly from clerical employment or jobs with an hourly wage.
CPI-W is used to adjust Social Security payments as well as other federal benefits and pensions for changes in the cost of living. It also shifts federal income tax brackets to ensure taxpayers aren't subjected to a higher marginal rate as a result of inflation.
Categories of CPI
The monthly CPI release from the BLS leads with the change from the prior month for the overall CPI-U as well as its key subcategories, along with the unadjusted change year-over-year. The BLS detailed tables show price changes for a variety of goods and services organized by eight umbrella spending categories.
Subcategories estimate price changes for everything from tomatoes and salad dressing to auto repairs and sporting events tickets. Price change for each subcategory is provided with and without seasonal adjustment.
In addition to the national CPI indexes, BLS publishes CPI data for U.S. regions, sub-regions, and major metropolitan areas. The metro data is subject to wider fluctuations and is useful mainly for identifying price changes based on local conditions.
The FED
The Fed uses CPI data to determine economic policy. With a target inflation rate of 2%, the Fed may enact expansionary monetary policy to stimulate the [economy]£{@leoglossary/leoglossary-economy} should market growth slow, or enact contractionary monetary policy should the economy (and therefore prices) grow too quickly. In response to higher-than-desired inflation rates via the CPI, the Fed adjusts the Fed funds rate.
Methodology of CPI
Because the CPI Index is so crucial to economic policy and decision-making, its methodology has long been controversial, drawing claims it either understates or overstates inflation. A panel of economists commissioned by Congress to study the issue in 1995 concluded the CPI overstated inflation and was followed by calculation changes to better reflect substitution effects.
More recently, critics have claimed that adjustments for changes in product quality and features understate the CPI. According to the BLS, the particularly controversial hedonic adjustments, which use regression techniques to adjust prices for new features on a relatively small proportion of the CPI items, have a net effect close to zero on the index.
As the traditional CPI-U calculation only measures inflation for urban populations, it remains a less-than-reliable source of data for individuals living in rural areas. In addition, the CPI does not explicitly state how different demographics may be impacted by inflation. For example, soaring education costs may adversely impact younger individuals, while the impact of increasing elderly care costs is felt by a different group of individuals.
This notion is also widely attributable to individuals with varying degrees of income. For example, lower-income individuals who contribute more gross income towards necessities of shelter and food will skew differently than households with larger disposable income. For this reason, the CPI may not adequately reflect each individual's experience in regard to costs and changes over time.
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