U.S. Consumer Price Index (CPI)

The Consumer Price Index (CPI) is a measure of how prices paid by U.S consumers change over time for representative basket of goods and services, making it a key economic indicator of consumer inflation and purchasing power. CPI is a crucial way to assess inflation and changes in purchasing trends for projecting growth and informing central banks on monetary policy settings.

Economists and policy makers use the CPI to understand inflation trends and inform necessary policy adjustments to balance economic trends. CPI is closely watched by fixed income investors because inflation directly affects yield curves and real estate. Tracking data on consumer buying habits and price trends, economists and policy makers use the CPI to understand inflation trends and inform necessary policy adjustments to balance economic trends. CPI is closely watched by fixed income investors because inflation directly affects yield curves and real estate.

U.S. Consumer Price Index (Year over Year)           

Typically, monetary policy authorities and governments prefer to evaluate inflation on an annual or year-over-year basis. Year-over-year (YoY) data is used to examine changes compared to the same period last year, while month-over-month (MoM) is used to compare changes from the previous month. It is important to note that both measures use the same underlying data; only the historical comparisons differ.

The seasonally adjusted CPI accounts for cyclical effects on price data and is published monthly as an economic time series. By tracking the percentage change in the prices for the basket of products and services over the year and removing anomalies that occur in specific seasons, a clearer overall picture of price movements can be achieved. This seasonally adjusted data is used to develop and revise economic policies and for economic research.

That said, unadjusted data is often used to calculate true price changes on a month-to-month basis and collective bargaining. Sampling errors can occur when dealing with a sample of data rather than the full set. Although seasonal adjustments remove certain anomalies, they do not eliminate sampling errors.

Who uses the Consumer Price Index?

The U.S. Consumer Price Index is closely monitored by U.S. policymakers, financial markets, businesses and consumers. CPI prints can tighten or loosen market liquidity as traders adjust risk.

The Federal Reserve uses CPI as a guide for adjusting its monetary policies as part of the ‘dual mandate’ – a balance of steady inflation and natural ‘full’ employment.

Financial markets closely watch CPI as an inflation gauge that informs important interest rate forecasts, while businesses and consumers also rely on the CPI to make informed economic decisions.

 As the CPI measures consumer purchasing power changes, it plays a pivotal role in wage negotiations and cost-of-living adjustments. CPI releases often move securities prices as investors reposition around interest rate expectations.

The formula for CPI is:

(Cost of products or services in the current period / Cost of products or services in a previous period) × 100

The inflation measure is calculated by the BLS using prices on approximately 80,000 products collected monthly from around the country across 23,000 retail and service establishments in seventy-five urban areas. By considering production cycles, CPI helps assess the impact of inflation on family budgets.

The importance of CPI

The U.S. Federal Reserve is tasked with maintaining both price stability and maximum employment, known as its ‘dual mandate.’

CPI is a primary indicator used to forecast interest-rate changes, linked to inflation data as well as borrowing cost impacts. As per estimates of this mandate, the central bank’s inflation target is 2.0% (YoY.) However, due to various factors, including the pandemic, consequential policy reactions, and geopolitical conflicts, inflation became for a time the most volatile pillar of the central bank’s directive, with the Consumer Price Index (CPI) reaching multi-decade highs in 2022.

In response, the Federal Reserve implemented measures to combat inflation, such as interest rate hikes and monetary tightening.

Historically, CPI and unemployment are not always inversely correlated, so the Federal Reserve risks a curb on one leg of its objective while potentially exacerbating a deviation from target for the other. Unexpected CPI transitions can cause significant movements along the yield curve.

U.S. inflation rate

The Bureau of Labor Statistics (BLS) calculates the inflation rate by comparing the current year's CPI to the prior year's CPI.

Inflation rate = (New CPI – Prior CPI/Prior CPI) x 100

The inflation rate is typically calculated over a specific month or year but quarterly is another typical tenor. To compute it, you must select the correct index value for the new and prior periods. The inflation rate is expressed as a percentage change.

It is necessary to monitor inflation trends alongside CPI as this relationship indicates the purchasing power of currency relative to the basket of goods. From a theoretical perspective, high inflation necessitates more money to purchase a fixed amount of goods.

Inflation has been influenced by supply-chain disruptions and geopolitical risk.

U.S. Bureau of Labor Statistics (BLS)

The U.S. Bureau of Labor Statistics (BLS) calculates US CPI by taking a weighted average of the prices for a select basket of goods and services that is meant to represent the total spending by U.S. consumers.

The composition of this basket can be influenced by several factors, such as technological advancements, government policies, and shifts in consumer behavior. By highlighting the interconnection between numerous sectors of the economy, the basket helps policymakers understand the implications of the policies they implement. CPI trends also influence expectations for U.S GDP growth and broader economic performance.

Urban consumers and urban wage earners

The Consumer Price Index for All Urban Consumers (CPI-U) accounts for over 90% of the United States’ population living in urban areas and does not include individuals residing in rural areas, farm households or military bases. The CPI-U tracks urban consumers and is the foundation for the headline of CPI numbers that are so influential in financial markets.

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) focus on households where the primary source of income comes from clerical workers or hourly wages, representing approximately 30% of the country's population. CPI-W is used to adjust Social Security payments, federal benefits, and pensions to account for changes in the cost of living. It also influences federal tax brackets so that taxpayers do not face a higher marginal rate due to inflation.

Changes in the CPI-U further affect the eligibility criteria for millions who receive food stamps and school lunch assistance programs. Additionally, private firms and individuals use CPI-U to adjust alimony payments, rents, royalties, and child support payments to reflect changing costs.

Consumer Price Index components

• The Consumer Price Index is made up roughly of the following components:
• Food: 13.7%
• Energy: 6.6%
• All items ex. food and energy: 79.7%

The eight major categories of the CPI are: Housing, Transportation, Education and Communication, Other Goods and Services, Recreation, Medical Care, Apparel, and Food and Beverages.

When considering long-term trends, Core CPI’ is used to track inflationary changes in goods and services excluding food and energy. By excluding volatile price movements in these sectors, economists can better assess underlying inflation trends.

Core CPI is useful for understanding long-term inflation trends because of those particular components, which tend to fluctuate significantly.

Read our 2024 Consumer Price Index (CPI) analysis for a deeper look into inflation trends and economic impacts.

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This material is for informational purposes only and should not be considered as an investment recommendation or a personal recommendation.