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The Consumer Price Index (CPI) measures the price change in a weighted basket of goods and services over time. The CPI is one of the most common measures of inflation, and when the media, investors, economists and others discuss inflation, they’re usually referring to the CPI.

Here’s what you should know about the CPI, how it’s calculated and its potential impact on you.

What is the Consumer Price Index and how does it work?

The CPI tracks the changes in the cost of a basket of products and services over a period of time. This basket, representative of the spending habits of the majority of urban consumers, includes a wide array of items, from food and medical care to transportation services.

By capturing price changes for each item in this basket, the CPI serves as a reliable measure of inflation or deflation. In other words, it provides a snapshot of how much it costs for consumers to maintain their standard of living and acts as a key tool for identifying periods of economic inflation or deflation.

The monthly CPI report contains two key inflation numbers:

  • Month-over-month price changes: This figure shows how prices have changed relative to the prior month’s prices. So this aspect of a report shows, for example, how March’s prices changed relative to February’s prices.
  • Year-over-year price changes: This figure shows how prices have changed relative to the same month in the prior year. For example, a report may show how June 2024 prices compare to June 2023 prices.

Generally, the year-over-year figure is what most people use when talking about inflation. This annualized number provides more context when thinking about prices, offering up a full year’s comparison, as opposed to a month-over-month comparison, which may show more “noise.”

“Americans who notice that the prices of eggs or gasoline are higher from one week to the next might be quick to blame inflation, but the wallet-damaging kind that Fed officials fear most won’t happen overnight,” says Sarah Foster, Bankrate principal reporter on the U.S. economy. “Economists and the Fed look for a broad-based, sustained increase in prices, which takes time to build.”

Here’s a recent snapshot of the CPI as well as year-ago figures.

What comprises the Consumer Price Index (CPI)?

The CPI is calculated using the prices of tens of thousands of different goods and services. The U.S. Bureau of Labor Statistics (BLS) classifies expenditures into more than 200 categories that are arranged into eight major groups.

  • Food and beverages
  • Housing
  • Apparel
  • Transportation
  • Medical care
  • Recreation
  • Education and communication
  • Other goods and services

For each of these categories the CPI data drills deep into pricing. For example, in the category of food and beverages, the index tracks individual prices such as for flour, breakfast cereal, rice, pasta, cakes, beef, pork, milk and many, many more items.

The CPI also includes various government-charged user fees, such as for water and sewerage, car registration, and vehicle tolls, as well as sales and excise taxes associated with the prices of specific goods and services.

However, it excludes income taxes and Social Security taxes, which are not purchases of consumer goods and services. It also doesn’t include investments such as stocks, real estate, bonds and life insurance, which are not daily consumption expenses.

How are prices collected for the CPI?

Collecting prices for the CPI is a meticulous process. Each month, the BLS gathers data from approximately 23,000 retail and service establishments, along with rental data from thousands of landlords or tenants, generating about 94,000 price quotes.

Price data is collected throughout the month across three pricing periods in 75 urban areas, ensuring comprehensive coverage of prices. This methodology enables the CPI to measure the change in prices for a market basket of commonly purchased goods and services.

Despite its critical role, CPI has limitations, such as not capturing the inflation experiences of rural populations or different demographic subgroups, and potential substitution bias, which can overstate cost-of-living changes.

How does the CPI calculation work?

The annual CPI is calculated by dividing the value of the basket of goods today by the value from a year ago and multiplying by 100. This formula determines the overall inflation rate, which is the percentage change in the CPI over a given time period.

In January 2024, the CPI increased 3.1 percent over the previous 12 months before any seasonal adjustments.

What are the different types of CPI?

While analysts often talk about “the” CPI, they’re referring to the CPI for all urban consumers (CPI-U), but several other types of CPI exist, too. These other versions of the CPI capture different pricing trends, depending on their re-weighting of the basket of goods and services.

The BLS publishes two main types of CPIs each month.

  • The Consumer Price Index for All Urban Consumers (CPI-U), which covers about 93 percent of the U.S. population, excluding those living in remote rural areas, farm households, institutions, or on military bases. The CPI-U is the most commonly cited index when referring to changes in consumer prices.
  • The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), covers approximately 29 percent of the U.S. population. This index is used predominantly for adjusting Social Security payments and other federal benefits, as well as for shifting federal income tax brackets to prevent bracket creep due to inflation.

But other prices indexes are calculated using prices from the base CPI-U:

  • Chained Consumer Price Index for all urban consumers (C-CPI-U): Known as the chained CPI, this index uses more up-to-date weightings for the price data and models consumer spending behavior in response to price changes (for example, consumers trading down to a cheaper product when its price becomes relatively cheaper).
  • Consumer Price Index for Americans 62 years of age and older (R-CPI-E): This index re-weights prices from the CPI-U data to track spending for households with at least one consumer age 62 or older.
  • Core CPI: This measure of inflation starts with the CPI-U and then strips out the prices of food and energy due to their more volatile nature. The goal is to eliminate “noisy” data in order to get a clearer look at the underlying trends of inflation.

In addition, the BLS can slice and dice the data by various factors, including:

  • Geography, looking at just a city or region of the country, for example
  • A specific subset of price data, such as rental prices, food or the popular core CPI, which excludes food and energy prices
  • Time period, with data going back decades

Another popular monthly inflation gauge is the Personal Consumption Expenditures (PCE) index. This index is tracked and managed by the U.S. Bureau of Economic Analysis (BEA).

How does the CPI affect the economy and consumers?

The CPI serves as a crucial tool for policymakers, financial markets, businesses, and consumers. By keeping a close eye on it, they can assess the state of the economy and make well-informed decisions. Inflation affects the purchasing power of money and guides economic policy decision-making, such as interest rate decisions by the Federal Reserve.

“Inflation data can be likened to a compass, guiding officials on the Federal Reserve as they decide whether they should raise interest rates and by how much,” says Foster. “But inflation data also matters to everyday Americans more than they might think, from the retirees relying on fixed income to the Americans hoping to ensure that their pay keeps pace with rising prices.”

Investors pay close attention to CPI data to understand how the Federal Reserve may act, and whether it may adjust interest rates in response to the prevailing price trends. Potential homebuyers then want to pay attention to inflation data since it may affect their mortgage rates.

Furthermore, the CPI influences government benefits adjustments, such as Social Security payments and federal tax brackets, to account for cost-of-living changes. Companies also use CPI data to inform decisions on wage increases, ensuring that salaries keep pace with inflation. The IRS uses the CPI to help guide decisions on tax deductions and other indexed amounts.

The CPI is also important for contracts with escalation agreements tied to price increases. These contracts include labor union contracts, rental agreements with annual escalators, inflation-protected insurance policies, alimony and child support payments, among others.

Bottom line

The CPI looks at how the prices for a basket of goods and services changes over time to measure how prices are changing. The CPI is the most widely cited measure of inflation and is used by consumers, economists, policymakers and others in their economic decisions.