What Is the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) measures the monthly change in prices paid by U.S. consumers. The U.S. 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, prices sample and index weights than the producer price index (PPI), which measures change in the prices received by U.S. producers of goods and services.
- The Consumer Price Index measures the overall change in consumer prices over time based on a representative basket of goods and services.
- The CPI It is the most widely used measure of inflation, closely followed by policymakers, financial markets, businesses, and consumers.
- The widely quoted CPI is based on an index covering 93% of the U.S. population, while a related index covering wage earners and clerical workers is used for cost-of-living adjustments to federal benefits
- The CPI is based on about 94,000 price quotes collected monthly from some 23,000 retail and service establishments as well as 43,000 rental housing units
- Housing rents are used to estimate the change in shelter costs including owner-occupied housing that account for nearly a third of the CPI.
The Consumer Price Index
Understanding the Consumer Price Index (CPI)
The BLS collects about 94,000 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 U.S. population.
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.
Shelter category prices accounting for nearly a third of the overall CPI are based on a survey of rental prices for 43,000 housing units, which is then used to calculate the rise in rental prices as well as owners' equivalent. The owners' equivalent category models the rent equivalent for owner-occupied housing to properly reflect housing costs' share of consumer spending.
The calculation of the CPI indexes from the data factors in substitution effects—consumers' tendency to shift spending away from products and categories grown relatively more expensive. It also adjusts price data for changes in product quality and features. The weighting of the product and services categories in the CPI indexes corresponds to recent consumer spending patterns derived from a separate survey.
The BLS publishes two CPI indexes each month.
- The Consumer Price Index for All Urban Consumers (CPI-U) represents the 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 Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) covers the 29% of 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.
The Consumer Price Index increased 1.0% in May 2022 and was up 8.6% year-over-year.
How is the CPI Presented?
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 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 the price changes based on local conditions.
How Is the Consumer Price Index (CPI) Used?
The CPI is widely used by financial market participants to gauge inflation and by the Federal Reserve to calibrate its monetary policy. Businesses and consumers also use the CPI to make informed economic decisions. Since CPI measures the change in consumers' purchasing power, it is often a key factor in pay negotiations.
The CPI and its components are also used as a deflator for other economic indicators, including retail sales and hourly/weekly earnings, to separate fundamental change from that reflecting change in prices.
The cost-of-living adjustments (COLAs) based on the CPI affect federal payments to the approximately 70 million Americans receiving Social Security and Supplemental Security Income (SSI) benefits. They also apply to federal pension payments, school lunch subsidies and income tax brackets.
Critiques of CPI Methodology
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.
How Is the Consumer Price Index (CPI) Used?
The CPI Index is an inflation indicator closely watched by policymakers and financial markets. A related CPI measure is used to calculate cost-of-living adjustments (COLAs) for federal benefit payments.
How Is the CPI Calculated?
The Bureau of Labor Statistics samples 94,000 prices monthly to calculate the CPI, weighing the index for each product or service in proportion to its share of recent consumer spending to calculate the overall change in prices. The calculation also factors in the substitution effect as consumers shift spending away from the products rising in price on a relative basis. The CPI also adjusts for changes in product quality and features. The numbers are provided with and without seasonal adjustments.
What Are Some Criticisms of the CPI?
Over the years, the CPI has frequently drawn criticism that it has either understated or overstated inflation. Because the CPI is based on consumer spending, it doesn't track third-party reimbursements for healthcare, and significantly underweights healthcare relative to its proportion in the GDP as a result. On the other hand, criticism concerning the quality adjustments used in the CPI has been widely discounted by economists.