Is the consumer price index (CPI) the best measure of inflation?

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The consumer price index (CPI) is a measure of the average change over time in the prices paid by consumers in urban households for a basket of goods and services. These goods and services are broken into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education, and communication.

The CPI is calculated by taking price changes for each item in the predetermined basket of consumer goods and services and then averaging them. Changes in the CPI reflect changes in the cost of living in the U.S. As such, the CPI is an economic indicator that is most frequently used for identifying periods of inflation (or deflation) in the U.S.

Key Takeaways

  • The consumer price index (CPI) is a measure of the average change over time in the prices paid by consumers in urban households for a basket of goods and services.
  • Changes in the CPI reflect changes in the cost of living in the U.S.
  • The CPI is an economic indicator that is most frequently used for identifying periods of inflation (or deflation) in the U.S.
  • While the CPI is the most widely watched and used measure of the U.S.’s inflation rate, many economists differ on how they believe inflation should be measured.
  • For a more accurate and comprehensive measure of inflation rates in the U.S., the PPI and the GDP deflator can be assessed in tandem with the most recently reported CPI measurements.

Changes in the Consumer Price Index (CPI) Reflect Overall Price Changes

Inflation is a rise in the general level of prices and is often expressed as a percentage. It results in a unit of currency effectively buying less than it did in prior time periods. When inflation occurs in the U.S., it indicates a decrease in the purchasing power of the dollar.

Changes in the CPI reflect price changes in the economy. When there is an upward change in the CPI, this means there has been an increase in the average change in prices over time. This eventually leads to adjustments in the cost of living and income (presumably so that income is adjusted to meet a higher cost of living). This process is referred to as indexation.

Consumer Price Index (CPI) Subcategories

The CPI provides many different subcategories of price indexes. In total, there are indexes for the U.S., the four Census regions, the nine Census divisions, two size of city classes, eight cross-classifications of regions and size-classes, and for 23 local areas. The U.S. Bureau of Labor Statistics (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 CPI-U and the CPI-W. The CPI-U is for all urban consumers and covers approximately 93 percent of the total population. The CPI-U includes professionals, the self-employed, the poor, the unemployed, and the retired–all residing in urban and metropolitan areas.

The CPI-W is for all urban wage earners and clerical workers. This accounts for an additional 29 percent of the population. This measurement skews more towards active workers and those in the lower social classes.

The current CPI measurements do not take into account the spending habits of those living in rural or non-metropolitan areas, including farm families. The current CPI measurements also do not take into account members of the armed forces and those in institutions, such as prisons or mental hospitals.

Economists Differ on How Inflation Should Be Measured

While the CPI is the most widely watched and used measure of the U.S.’s inflation rate, many economists differ on how they believe inflation should be measured. Because the methodology used to calculate the CPI has changed over time–undergoing numerous revisions–there are some critics of the CPI that say that this measurement can be purposefully manipulated by the U.S. government. Other economists argue that the CPI’s viability as an indicator of inflation is questionable simply because it may be a lagging indicator. In other words, it may not be very accurate at capturing current levels of inflation.

The BLS also uses additional indexes to measure inflation. The producer price index (PPI) measures the domestic output of raw goods and services. It attempts to account for the fact that, when producers face input inflation, the increase in their production costs are passed on to the retailers and consumers. Hence, the PPI is a more accurate measure of a country’s economic output because it is not affected by consumer demand.

The BLS also uses the gross domestic product (GDP) deflator as an additional indicator of the level of inflation in the U.S. The GDP deflator measures the aggregate prices of all goods and services produced by the entire nation; it encompasses both the CPI and PPI statistics.

For a more accurate and comprehensive measure of inflation rates in the U.S., the PPI and the GDP deflator can be assessed in tandem with the most recently reported CPI measurements.



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