How it’s Used to Calculate Inflation

Inflation is the rate at which the prices of goods and products rise over a particular time period. The concept is typically a broad measure and includes an overall upsurge in the price or increase in the cost of living of a particular nation. The rise in product prices simply erodes the purchasing power of businesses and consumers. CPI is one of the widely used tools for measuring inflation, sometimes considered an indicator of the government’s economic policy.

To understand how CPI helps in measuring the inflation rate one needs to know the concept in detail.

The Basics of CPI

Consumer Price Index (CPI) was introduced by BLS in 1919 with an initiative of consumer price indexes for 32 cities. The regular publication of the national index began in 1921 and emerged as one of the widely used measures of inflation. The concept measures the overall change in consumer prices based on a representative basket of products and services over time. Simply, it is a family of indexes that measures the price change experienced by urban consumers.

In the US, each month a CPI is constructed using 80,000 items in a fixed basket which Americans buy in their everyday lives. The list involves everything from fuel to groceries and electronics to doctor visits. A survey called Consumer Expenditure Survey is carried out to determine which items to add to the basket. The price of the items is defined based on the weight and demand of the same to the average consumer.

The CPI report changes from one month to the next, but the fashion in the monthly change over several months signs inflation. Also, CPI-U and CPI-W are the two main types of CPI published by BLS every month.

CPI-U is Consumer Price Index for all urban consumers and includes around 93% of the US population not living in rural areas. CPI-W or Consumer Price Index for Urban Wage Earners and Clerical Workers, on the other hand, involves 29% of the US population living in households with a source of income from clerical employment or jobs.

After knowing the basics of CPI and how items are indexed, it’s time to explore how CPI measures inflation.

How Does CPI Measure Inflation?

CPI is one of the most popular and widely used measures of inflation and deflection and uses different price samples, survey methodology, and index weights.

To calculate the CPI, BLS uses the current year’s CPI and the previous year’s CPI which can be measured for a given month or annual period. The measurement simply requires appropriate new and previous period CPI.

CPI is majorly used by financial institutions to measure inflation and calibrate monetary policy. The Federal Reserve, government agencies, housing agencies, financial markets, and labor markets mainly use the concept of CPI.

Conclusion

CPI simply measures the overall variation in consumer prices based on a basket of products and services over time. The tool is also used for calculating the inflation rates and is mainly used by The Federal Reserve, government agencies, housing agencies, financial markets, and labor markets in the US.