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Consumer Price Index (CPI Index)

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food is part of the consumer price index

Food prices are a volatile component of the Consumer Price Index.(Photo: Elly Lange / Getty Images)

What Is the Consumer Price Index?:

The Consumer Price Index, or CPI, is defined as the monthly measurement of U.S. prices of just about everything you buy. If prices go up, that's inflation. If they go down, that's deflation. The Bureau of Labor Statistics (BLS) surveys the prices of 80,000 consumer items to create the index. It represents the prices of a cross-section of goods and services commonly bought by primarily urban households. However, these metropolitan households represent 87% of the U.S. population.

How the Consumer Price Index Is Calculated:

The BLS collects price information from 23,000 retail and service businesses. The businesses chosen are the types frequented by a sample of 14,500 families. The CPI includes sales taxes, but excludes income taxes and the prices of investments such as stocks and bonds. 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. (Source: BLS, Frequently Asked Questions)

More important, the CPI 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 gives a false low reading when home prices are high (and rents are low). This is why it did not warn of asset inflation during the housing bubble of 2005.

Why the CPI Is Important:

The CPI measures inflation, which is one of the greatest threats to a healthy economy. Therefore, its most important function is to be used by the Federal government to determine whether economic policies need to be modified to prevent inflation. Second, the CPI is used to adjust prices in other government economic indicators, such as Gross Domestic Product, or GDP. Third, the index is used to adjust benefit levels for recipients of Social Security and other government programs.

Core Consumer Price Index:

Two measures of inflation are often reported: core CPI, which does not include food and energy cost, and non-core CPI, which includes everything. 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, oil and gas prices are so volatile and the Fed's tools are so slow-acting. Therefore, inflation could be high if gas prices have risen, but the Fed won't react until those increases trickle through to the prices of other goods and services.

Historical Consumer Price Index:

Historical CPI numbers can best be found on the BLS website. The agency provides a history of the Consumer Price Index for every month since 1912. The monthly history of the core CPI is available for every month since 1956. The history of CPI by city or by product category can also be selected. (Most Requested Statistics. CPI history is also available by monthly changes or year-to-year changes. (CPI website, CPI-U, US City Average, All Items: Historical Numbers)

Current CPI:

Currently, the Consumer Price Index is not reporting a threat from inflation. Why not? First, low-cost Chinese imports and technology improvements have kept prices down for the last decade. Second, the recession depressed economic growth, which lowered demand and prevented businesses from raising prices. Instead, they cut costs, resulting in high unemployment.

However, many are worried that the Fed's expansionary monetary policy will trigger inflation. In addition, as global demand rises, inflation could once again rearing its ugly head. Fortunately, the core CPI is still within the Fed's 2% target inflation rate. For the latest numbers, see Current Inflation Rates.

CPI Calculator:

The BLS publishes a great little inflation calculator. You can plug in the dollar value for any year from 1913 to the present, and it will tell you what it's worth for any year from 1913 to the present. It uses the average Consumer Price Index for that calendar year. For the current year, it uses the latest monthly index. To try it out, go to CPI Inflation Calculator. If you don't want to do the work yourself, I've done it for you for every decade since 1913 in What Is the Value of a Dollar Today?. Article updated January 26, 2013
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