What Is CPI & Why Is It Important?

The CPI (Consumer Price Index), often called the "cost-of-living index," affects you in different ways. The math that drives this calculation may be out-of-sight, out-of-mind to the average consumer, but the bottom line likely impacts your everyday life in some pretty significant ways. To name a few applications, CPI data influence cost-of-living wage adjustments, the federal income tax structure and Capitol Hill monetary policies.

The CPI as a Measure of Inflation

The CPI isn't a single index, but a group of indices, all of them compiled by the U.S. Department of Labor, each for a slightly different purpose. The Bureau of Labor Statistics (BLS) calculates the CPI version used to measure inflation once a month, analyzing the cost of a "basket of goods," in eight major consumer areas, then comparing the cost in the most recent period with the cost of the same basket in previous periods. Within each of these eight major areas, the BLS analyzes several subareas, reporting on them as well, and provides a detailed analysis of the rise of consumer prices.

Energy costs, for instance, rose 7.9 percent in the year preceding April 2018, but within that sector fuel prices, one of six subsectors, rose the most, increasing by 22 percent. Costs for natural gas and electricity, however, rose only about 1 percent.

Using this sector-based measuring method, the BLS determined that year over year, for the year ending in April 2018, consumer prices overall had risen 2.5 percent.

Why the CPI Is Controversial

Most consumers, if they think about the CPI at all, view it as a monolithic single measure that provides a reliable and consistent measure of, among other things, inflation.

Nothing could be further from the reality of the index. A short, brilliant and devastating article in Forbes by Perianne Boring, formerly a financial analyst for the U.S. House of Representatives, noted, among other deficiencies and dubious practices, that:

• The BLS has changed the basis of the inflation calculation over 20 times in the past 30 years.
  
• It makes numerous "adjustments" to the index, but won't disclose how it arrives at them for reasons that aren't convincing.
• And, most significantly, that the trend of these adjustments has been to skew the inflation rate further downward.

Boring concludes that it is in the government's financial interests to minimize the inflation rate because it lowers its costs.

CPI-U Vs. C-CPI-U

The most significant areas where lowering the inflation rate lowers government costs are Social Security and Medicare, both of which, by Congressional mandate, have payments tied to the inflation rate.

The CPI-U, or All Items Consumer Price Index for All Urban Consumers, is only one index in the CPI, but it's the most comprehensive, so it's often the number reported in the media.

In 2013, the BLS began estimating inflation for Social Security and Medicare payments using a different index, replacing CPI-U with a so-called "chained" index, the C-CPI-U. The details of this change are beyond the scope of this article. The BLS has stated that the new index is "more accurate," but there's wide agreement among analysts from conservative journals like Forbes, middle-of-the-road sites like Money Watch and even The Congressional Budget Office, that by reducing the calculated inflation rate by about .3 percent annually, the cumulative effect will be to significantly lower Social Security payments and Medicare benefits for future retirees.

The result is unsurprising because the two government commissions that came up with this new "more accurate" way of assessing the inflation rate were specifically tasked with finding a way of "balancing the budget." They accomplished this by reducing future payment amounts of two major entitlements.