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Financial Fact: What Is the Consumer Price Index and Why Is It Important?

 

You may have heard the term Consumer Price Index or CPI bandied about on the financial news or by economists – especially with inflation on everyone’s mind. The Consumer Price Index (CPI) is a data point measuring the average change over a certain period of time in what consumers pay for housing, goods and services. Simply put, it reflects consumers’ purchasing power. The index is available for the United States as a whole and is also broken down into various geographical areas.

Note that it only covers 93 percent1 of the US and is not a source of reliable information for rural parts of the country. Regions are broken down as follows: West, Midwest, South and Northeast. It is further broken down to nine smaller regions:

  • New England
  • Mid-Atlantic
  • East North Central
  • West North Central
  • East South Central
  • West South Central
  • Mountain and Pacific

There is also a CPI for each individual state in the US.

 

The CPI number is based on approximately 80,000 price quotes of goods and services from 23,000 different places along with 50,000 rental properties. It doesn’t include spending by the military, farms, or institutions. This number is known as the CPI for all Urban Consumers (CPI-U).2

There is a second CPI known as CPI for Urban Wage Earners and Clerical Workers (CPI-W), representing approximately 29%3 of the population in households with most of their income coming from clerical jobs or hourly wage positions. However, the CPI-U is most often used.

Since it shows changes in a consumer’s purchasing power, CPI is used to make economic decisions. Reported monthly, financial markets, policymakers, businesses and consumers keep their eye on how the number changes because it is an indication of both inflation and deflation. Deflation occurs when the prices of goods and services decrease across the entire economy, increasing the purchasing power of consumers. The Federal Reserve makes certain decisions based on the CPI and the financial markets react to their decisions. CPI impacts economic growth, corporate profits and consumer spending. Depending on the economic conditions, the Fed may stimulate or slow down the economy by adjusting interest rates using CPI as a major factor in their decision-making.

Cost of living adjustments, child support, pensions, social security, income tax brackets and income eligibility levels for government assistance are also based on CPI.

[1] https://www.bls.gov/cpi/

[2] https://www.bls.gov/cpi/research-series/r-cpi-u-rs-home.htm

[3] https://www.bls.gov/news.release/cpi.nr0.htm

 

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