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What is the Consumer Price Index (CPI)?
The economy is a hot topic right now. Chances are, you've heard journalists, lobbyists, politicians, and economists mention the Consumer Price Index (CPI) when discussing the current inflation rate and the need for an interest rate adjustment. But what is the CPI, and how does it affect you?
The CPI is an index that tracks the prices of everyday goods and services, such as groceries and gas. Over time, changes to the CPI can indicate issues with the economy, such as sky-high inflation rates or a housing crisis. Though the CPI may seem like a lofty concept, it has a substantial impact on your life.
Consumer Price Index definition
The CPI is an index that tracks the prices consumers paid for goods and services. It reports on price changes of your daily essentials, including food, fuel, housing, energy, clothing, and healthcare.
The report shows the change in pricing overall and in each category from month to month and over longer periods, such as price increases that occur over the course of 12 months.
For example, here's a snapshot of the latest CPI report:
As you can see in the above table, the prices of all items increased 0.2% between July and August 2024. Over the past 12 months, the prices of all items increased 2.5%.
Economists and government officials use the data reported in the CPI as a measure of inflation and economic health.
There are two main CPI types:
CPI for All Urban Consumers (CPI-U)
The CPI-U was launched in 2002 and has become the most commonly used index since its introduction. The index covers about 90% of the country's population, which is why it is so prominent.
It includes the spending habits of those who are employed, unemployed, retired, and self-employed.
CPI for Urban Wage Earners and Clerical Workers (CPI-W)
Sometimes referred to as the "blue-collar measure," the CPI-W is an index that tracks the price of food and services purchased by consumers who get the majority of their income from clerical or hourly wage jobs. This index has a narrower focus than the CPI-U; it only covers about 29% of the population.
How is the CPI calculated?
The CPI is updated on a monthly basis using pricing data from 75 urban areas across the country. It includes data collected from about 6,000 housing units and 22,000 retail establishments.
Each spending category is weighted according to its importance for the population group. Since food and energy — including fuel and electricity — are two critical spending categories for consumers, they tend to be the most heavily weighted.
The U.S. Bureau of Labor Statistics releases the updated CPI tables every month; you can view the latest report to see the price changes for the entire index and for individual categories.
CPI vs. other indexes
The CPI isn't the only pricing index economists and politicians consider. Two of the other major indexes include the Producer Price Index (PPI) and the Personal Consumer Expenditures (PCE) index.
CPI vs. PPI
As the name implies, the PPI measures the prices producers receive for the goods and services they sell.
It seems like the CPI and PPI would be quite similar since the PPI measures what producers receive and the CPI measures what consumers pay, but that's not always the case. Changes in pricing within the PPI index take into account some items that the CPI doesn't. For example, the PPI includes the cost of raw materials, and it doesn't include the cost of imported goods.
CPI vs. PCE
The CPI only measures what urban consumers pay for goods and services, while the PCE has a broader outlook. The PCE includes what rural and urban consumers pay, and it also takes into account what companies may pay on behalf of consumers. For example, the PCE considers health insurance expenses covered by employers or Medicare or Medicaid, while the CPI omits that data.
3 ways the CPI can affect you
The CPI can seem like a very complicated, abstract index. However, the CPI directly impacts your everyday life. If the CPI shows steep price increases, you've likely already experienced those price hikes yourself, but it can have a broader impact on your finances:
Economic health indicator
The government and economists use the CPI as one of the main indicators of inflation and the economy's overall health. By primarily examining rate changes over 12 months, the data reported by the CPI can prompt the government to take action through new policies or regulations.
Interest rate changes
The CPI is a key measure of inflation. The Federal Reserve, the central bank of the U.S., is tasked with maintaining an inflation rate of about 2% — the rate considered healthy for a functional and growing economy.
If the CPI gets too high, the Federal Reserve will introduce measures to slow price increases. For example, the 12-month rate for the CPI was 9.1% in June 2022. As a result, the federal funds rate — the rate that banks use to lend to one another — was raised several times. These rate changes affect everything from the annual percentage yield (APY) you earn on savings accounts to the rates you pay on mortgages and car loans.
When inflation cools, the Fed institutes rate cuts to stimulate the economy, which can reduce loan rates.
Government assistance program calculations
The government uses the CPI as a gauge for adjusting government benefit program payments. For example, the CPI is taken into account when the government adjusts income eligibility for government programs and implements cost-of-living adjustments.
The CPI has a direct impact on food stamp recipients, Social Security beneficiaries, and military and federal Civil Service retirees and survivors.
Understanding the CPI
The CPI is a useful tool to see how the prices of essentials have changed over time. However, there is little you can do as a consumer to manage those price increases and fluctuations. Instead, you can use the following tips to manage your finances when the CPI shows high price increases:
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Stick to a budget: When the CPI is high, sticking to a budget is critical. Limiting how much you spend on groceries, dining out, and other expenses can help you set aside money for a rainy day.
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Cut corners: If your budget doesn't have much breathing room, look for areas you can cut back or eliminate entirely. Canceling streaming services, app subscriptions, carpooling, or committing to cooking at home are all small ways to free up some extra cash.
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Open a high-yield savings account: A high-yield savings account (HYSA) helps you fight inflation and CPI increases. An HYSA is an excellent place to stash money you need for an emergency fund or other short-term goals. Right now, the best high-yield savings accounts pay upwards of 5.00% APY.
