What Is CPI & Why Is It Important?

One of the most watched economic indicators is the Consumer Price Index. The CPI is calculated by the Bureau of Labor Statistics, which is part of the Department of Labor. The CPI is updated and published on a monthly, quarterly and annual basis. The CPI, also known as the cost of living index, measures the cost of eight specific consumer expenditure groups. This information is then used to determine whether the inflation rate is rising or falling.

The CPI Price Basket

Eight major consumer expenditure groups make up the CPI price basket: Food and Beverage, Housing, Apparel, Transportation, Medical Care, Recreation, Education and Communication, and Other Goods and Services. The Other Goods and Services group includes haircuts, funeral expenses and tobacco and related product purchases. Each group contains a variety of goods and services purchased by consumers for personal use. Also included in the CPI basket are government charges for water and sewer usage, automobile registration fees and sales and excise taxes incurred while purchasing consumer goods and services.

CPI as an Inflation Indicator

Government agencies, businesses and consumers are concerned with inflation. The CPI acts as a barometer of the present inflation rate. The federal government uses CPI inflation information to implement fiscal policy changes. One way the Federal Reserve Board can slow inflation is by lowering the federal funds rate. The federal funds rate is the interest rate banks charge each other for interbank loans. This lower interest rate is passed on to consumers and slows the inflation rate.

CPI as an Economic Series Deflator

The CPI is used to determine the deflated value of an economic series and the dollar’s purchasing power. The dollars of an economic series such as retail sales, or hourly and weekly earnings are recalculated into inflation-free dollars so that prices can be compared against previous time periods. Because the CPI uses deflated dollars, it’s also very useful in measuring the dollar’s purchasing power. If the CPI basket prices decrease, the dollar’s purchasing power increases because it takes less money to buy the same goods.

CPI as a Dollar Value Adjuster

The US government uses CPI economic series deflator information to determine if a cost of living increase is warranted. The CPI affects how much Social Security payments, food stamp allotments and military retiree benefits are increased. It’s also used to adjust the cost of school lunch programs and union collective bargaining benefits. The CPI dollar value adjustment prevents taxes from being increased solely due to inflation. Businesses also use this information to help determine if employees should receive a cost of living wage increase.

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About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.

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