Consumer Price Index

What the Consumer Price Index Measures: The most commonly quoted measure of inflation is the Consumer Price Index (CPI), as measured monthly by the Bureau of Labor Statistics (BLS). The CPI measures the price of almost all goods and services purchased by urban households by collecting informatioon from 23,000 retail and service businesses. The complete list of everything it does measure, as well as the change in price for each item in 26 of the 87 cities measured, is on the BLS website.The CPI includes sales taxes, but excludes income taxes and the prices of investments such as stocks and bonds.

More importantly, it also does not include sales price of homes. Instead, it calculates the monthly equivalent of owning a home, which it derives from rents. This is very misleading, since rental prices are likely to drop when there is high vacancy, usually when interest rates are low and housing prices are rising. Conversely, when home prices are dropping due to high interest rates, rents tend to increase. Therefore, the CPI is likely to give an inaccurately low reading when home prices are high (and rents are low), and an inaccurately high reading when home prices are low (and rents are high).

Why the CPI is Important: The CPI measures inflation, which is one of the greatest threats to a healthy economy. Two measures of inflation are often reported: core, which does not include food and energy cost, and non-core, which includes everything.

Core inflation, or core CPI, is important because this is what the Federal Reserve looks at to decide whether or not to raise the Fed Funds rate. The Fed uses the Core CPI because food and energy, specifically gasoline, are so volatile and the Fed’s tools are so slow-acting. Therefore, inflation could be high if gas prices have increased dramatically, but the Fed would not react until those increases have trickled through to the prices of other goods and services.