Is the Consumer Price Index the Best Measure of Inflation?

The Consumer Price Index (CPI) measures inflation by tracking the changes in prices paid by consumers for a basket of goods and services over time. These goods and services include food and beverages, housing, apparel, transportation, medical care, recreation, education, and communication.

Using CPI to Measure Inflation

The Consumer Price Index is calculated by measuring the price in one period for a fixed basket of consumer goods and services compared to previous periods. Inflation is a rise in the general level of prices and is often expressed as a percentage. When inflation occurs in the U.S., the purchasing power of the dollar decreases.

The U.S. Bureau of Labor Statistics (BLS) reports the CPI monthly. It is based on the index average for the period from 1982 through 1984, which was set to 100. A CPI reading of 100 means that inflation is equal to the level in 1984, while readings of 175 and 225 would indicate a rise in the inflation level of 75% and 125%, respectively.

Changes in the CPI reflect price changes in the economy. When there is an upward change in the CPI, there has been an increase in the average change in prices over time. This leads to adjustments in the cost of living and income, a process referred to as indexation.

CPI Subcategories

There are indexes for the U.S., the four Census regions, the nine Census divisions, two sizes of city classes, eight cross-classifications of regions and size classes, and 23 local areas. The BLS publishes CPI data monthly for indexes related to the U.S., the four Census regions, and some local areas.

Indexes are also available for two population groups: the Consumer Price Index for All Urban Consumers (CPI-U) and the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).

• The CPI-U includes professionals, the self-employed, the unemployed, and the retired residing in urban and metropolitan areas.
• The CPI-W includes urban wage earners and clerical workers.

CPI measurements do not account for the spending habits of those living in rural or nonmetropolitan areas, including farm families. The CPI measurements also do not include members of the armed forces and those confined to prisons or mental health facilities.

Additional Indicators of Inflation

While the CPI is the most widely watched and used measure of the U.S. inflation rate, economists differ on how inflation should be measured. Besides the CPI, additional indexes help to measure inflation.

Producer Price Index

The Producer Price Index (PPI) measures the domestic output of raw goods and services. It recognizes that as producers face input inflation, the increases in their production costs are passed on to retailers and consumers. The PPI is a more accurate measure of a country’s economic output because it does not rely on consumer demand.

Gross Domestic Product (GDP) Deflator

The U.S. Bureau of Economic Analysis (BEA) uses the gross domestic product (GDP) deflator as an indicator of U.S. inflation. The GDP deflator measures the aggregate prices of all goods and services produced by the nation and encompasses both the CPI and PPI statistics.

The fixed?basket?used in CPI calculations is static and sometimes misses changes in the prices of goods outside the basket. Since GDP isn’t based on a fixed basket of goods and services, the GDP deflator has an advantage over the CPI. Changes in consumption patterns or new goods and services are automatically reflected in the GDP deflator but not the CPI.

GDP represents the total output of goods and services. The GDP deflator shows how much a change in GDP relies on changes in the price level. It expresses the extent of price level changes, or inflation, within the economy by tracking the prices paid by businesses, the government, and consumers.

Personal Consumption Expenditures (PCE) Price Index

Personal consumption expenditures (PCEs) are another measure of imputed household expenditures and how those costs change over time. PCEs are summarized in the Personal Consumption Expenditures Price Index, released monthly by the?BEA, and measure?price changes?in consumer goods and services exchanged in the U.S. economy.

In 2012, the PCE Price Index became the primary inflation index used by the U.S. Federal Reserve when making monetary policy decisions. It is used instead of the CPI because the PCE Price Index is composed of a broad range of expenditures that exceeds the limited basket of goods used in the CPI. The PCE Price Index is also weighted by data acquired through business surveys, which tend to be more reliable than the consumer surveys used by the CPI. 

The Bottom Line

The Consumer Price Index (CPI) measures the average change in prices for a basket of goods and services over time. The Bureau of Labor Statistics publishes the CPI monthly, which reflects changes in the cost of living in the U.S. Additional indexes also measure inflation and include the Personal Consumption Expenditures (PCE) Price Index, the Producer Price Index (PPI), and the Gross Domestic Product (GDP) deflator.