Take A Closer Look at CPI

I believe most of us who have already taken EC101/EC102 are very likely to be familiar with the concept of CPI, however, CPI is way more complicated than what we learned from our class and textbooks. In order to analyze the entire market(economy) as a whole, we need to take a closer look at CPI and fully understand the meaning behind this important economic indicator.

First of all, as we know that the Consumer Price Index (CPI) is the most widely quoted and well-known economic indicator and for good reason. This index measures changes in prices of goods and services to consumers – in other words, what we pay for a whole range of everyday needs.

If prices change too abruptly in either direction, it can spell trouble for the economy.

Although there is no direct systematic relationship between CPI index and stock market, consumer purchasing still has a significant indirect impact with the macro economy.

The following Q&A session drafted by BLS will answer most of the common questions about CPI.

How is the CPI used?

The CPI affects nearly all Americans because of the many ways it is used. Following are major uses:

  • As an economic indicator. More.
  • As a deflator of other economic series. More.
  • As a means of adjusting dollar values. More.

Whose buying habits does the CPI reflect?

The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers. The all urban consumer group represents about 87 percent of the total U.S. population. It is based on the expenditures of almost all residents of urban or metropolitan areas, including professionals, the self-employed, the poor, the unemployed, and retired people, as well as urban wage earners and clerical workers. Not included in the CPI are the spending patterns of people living in rural nonmetropolitan areas, farm families, people in the Armed Forces, and those in institutions, such as prisons and mental hospitals. Consumer inflation for all urban consumers is measured by two indexes, namely, the Consumer Price Index for All Urban Consumers (CPI-U) and the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). ( See the answer to Question 4 for an explanation of the differences between the CPI-U and C-CPI-U.)

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is based on the expenditures of households included in the CPI-U definition that also meet two requirements: more than one-half of the household’s income must come from clerical or wage occupations, and at least one of the household’s earners must have been employed for at least 37 weeks during the previous 12 months. The CPI-W population represents about 32 percent of the total U.S. population and is a subset, or part, of the CPI-U population.

Is the CPI a cost-of-living index?

The CPI frequently is called a cost-of-living index, but it differs in important ways from a complete cost-of-living measure. BLS has for some time used a cost-of-living framework in making practical decisions about questions that arise in constructing the CPI. A cost-of-living index is a conceptual measurement goal, however, and not a straightforward alternative to the CPI. A cost-of-living index would measure changes over time in the amount that consumers need to spend to reach a certain utility level or standard of living. Both the CPI and a cost-of-living index would reflect changes in the prices of goods and services, such as food and clothing, that are directly purchased in the marketplace; but a complete cost-of-living index would go beyond this role to also take into account changes in other governmental or environmental factors that affect consumers’ well-being. It is very difficult to determine the proper treatment of public goods, such as safety and education, and other broad concerns, such as health, water quality, and crime, that would constitute a complete cost-of-living framework. More.

Does the CPI measure my experience with price change?

Not necessarily. It is important to understand that BLS bases the market baskets and pricing procedures for the CPI-U and CPI-W populations on the experience of the relevant average household, not of any specific family or individual. It is unlikely that your experience will correspond precisely with either the national indexes or the indexes for specific cities or regions. More.

How is the CPI market basket determined?

The CPI market basket is developed from detailed expenditure information provided by families and individuals on what they actually bought. For the current CPI, this information was collected from the Consumer Expenditure Surveys for 2007 and 2008. In each of those years, about 7,000 families from around the country provided information each quarter on their spending habits in the interview survey. To collect information on frequently purchased items, such as food and personal care products, another 7,000 families in each of these years kept diaries listing everything they bought during a 2-week period.

Over the 2 year period, then, expenditure information came from approximately 28,000 weekly diaries and 60,000 quarterly interviews used to determine the importance, or weight, of the more than 200 item categories in the CPI index structure.

What goods and services does the CPI cover?

The CPI represents all goods and services purchased for consumption by the reference population (U or W) BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups. Major groups and examples of categories in each are as follows:

  • FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
  • HOUSING (rent of primary residence, owners’ equivalent rent, fuel oil, bedroom furniture)
  • APPAREL (men’s shirts and sweaters, women’s dresses, jewelry)
  • TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
  • MEDICAL CARE (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)
  • RECREATION (televisions, toys, pets and pet products, sports equipment, admissions);
  • EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);
  • OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).

Also included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. In addition, the CPI includes taxes (such as sales and excise taxes) that are directly associated with the prices of specific goods and services. However, the CPI excludes taxes (such as income and Social Security taxes) not directly associated with the purchase of consumer goods and services.

The CPI does not include investment items, such as stocks, bonds, real estate, and life insurance. (These items relate to savings and not to day-to-day consumption expenses.)

For each of the more than 200 item categories, using scientific statistical procedures, the Bureau has chosen samples of several hundred specific items within selected business establishments frequented by consumers to represent the thousands of varieties available in the marketplace. For example, in a given supermarket, the Bureau may choose a plastic bag of golden delicious apples, U.S. extra fancy grade, weighing 4.4 pounds to represent the Apples category.

How are CPI prices collected and reviewed?

Each month, BLS data collectors called economic assistants visit or call thousands of retail stores, service establishments, rental units, and doctors’ offices, all over the United States, to obtain information on the prices of the thousands of items used to track and measure price changes in the CPI. These economic assistants record the prices of about 80,000 items each month, representing a scientifically selected sample of the prices paid by consumers for goods and services purchased.

During each call or visit, the economic assistant collects price data on a specific good or service that was precisely defined during an earlier visit. If the selected item is available, the economic assistant records its price. If the selected item is no longer available, or if there have been changes in the quality or quantity (for example, eggs sold in packages of ten when they previously were sold by the dozen) of the good or service since the last time prices were collected, the economic assistant selects a new item or records the quality change in the current item.

The recorded information is sent to the national office of BLS, where commodity specialists who have detailed knowledge about the particular goods or services priced review the data. These specialists check the data for accuracy and consistency and make any necessary corrections or adjustments, which can range from an adjustment for a change in the size or quantity of a packaged item to more complex adjustments based upon statistical analysis of the value of an item’s features or quality. Thus, commodity specialists strive to prevent changes in the quality of items from affecting the CPI’s measurement of price change.

How is the CPI calculated?

The CPI is a product of a series of interrelated samples. First, using data from the 1990 Census of Population, BLS selected the urban areas from which data on prices were collected and chose the housing units within each area that were eligible for use in the shelter component of the CPI. The Census of Population also provided data on the number of consumers represented by each area selected as a CPI price collection area. Next, another sample (of about 14,500 families each year) served as the basis for a Point-of-Purchase Survey that identified the places where households purchased various types of goods and services. More.

How are taxes treated in the CPI?

Certain taxes are included in the CPI, namely, taxes that are directly associated with the purchase of specific goods and services (such as sales and excise taxes). Government user fees are also included in the CPI. For example, toll charges and parking fees are included in the transportation category, and an entry fee to a national park would be included as part of the admissions index. In addition, property taxes should be reflected indirectly in the BLS method of measuring the cost of the flow of services provided by shelter, which we called owners’ equivalent rent, to the extent that these taxes influence rental values. Taxes not directly associated with specific purchases, such as income and Social Security taxes, are excluded, as are the government services paid for through those taxes.

For certain purposes, one might want to define price indexes to include, rather than exclude, income taxes. Such indexes would provide an answer to a question different from the one to which the present CPI is relevant, and would be appropriate for different uses.

How do I read or interpret an index?

An index is a tool that simplifies the measurement of movements in a numerical series. Most of the specific CPI indexes have a 1982-84 reference base. That is, BLS sets the average index level (representing the average price level)-for the 36-month period covering the years 1982, 1983, and 1984-equal to 100. BLS then measures changes in relation to that figure. An index of 110, for example, means there has been a 10-percent increase in price since the reference period; similarly, an index of 90 means a 10-percent decrease. Movements of the index from one date to another can be expressed as changes in index points (simply, the difference between index levels), but it is more useful to express the movements as percent changes. This is because index points are affected by the level of the index in relation to its reference period, while percent changes are not.

In the table that follows, Item A increased by half as many index points as Item B between Year I and Year II. Yet, because of different starting indexes, both items had the same percent change; that is, prices advanced at the same rate. By contrast, Items B and C show the same change in index points, but the percent change is greater for Item C because of its lower starting index value.

 

 

Item A Item B Item C
Year I 112.500 225.000 110.000
Year II 121.500 243.000 128.000
Change in index points 9.000 18.000 18.000
Percent change 9.0/112.500 x 100 = 8.0 18.0/225.000 x 100 = 8.0 18.0/110.000 x 100 = 16.4

 

Is the CPI the best measure of inflation?

Inflation has been defined as a process of continuously rising prices or equivalently, of a continuously falling value of money.

Various indexes have been devised to measure different aspects of inflation. The CPI measures inflation as experienced by consumers in their day-to-day living expenses; the Producer Price Index (PPI) measures inflation at earlier stages of the production process; the Employment Cost Index (ECI) measures it in the labor market; the BLS International Price Program measures it for imports and exports; and the Gross Domestic Product Deflator (GDP Deflator) measures inflation experienced by both consumers themselves as well as governments and other institutions providing goods and services to consumers. Finally, there are specialized measures, such as measures of interest rates.

The “best” measure of inflation for a given application depends on the intended use of the data. The CPI is generally the best measure for adjusting payments to consumers when the intent is to allow consumers to purchase at today’s prices, a market basket of goods and services equivalent to one that they could purchase in an earlier period.

Which index is the “Official CPI” reported in the media?

Our broadest and most comprehensive CPI is called the All Items Consumer Price Index for All Urban Consumers (CPI-U) for the U.S. City Average, 1982-84 = 100.

In addition to the All Items CPI, BLS publishes thousands of other consumer price indexes. One such index is called “All items less food and energy”. Some users of CPI data use this index because food and energy prices are relatively volatile, and these users want to focus on what they perceive to be the “core” or “underlying” rate of inflation.

Again, while we publish many indexes, our broadest measure of inflation includes all items consumers purchase, including food and energy. In addition, when CPI data are reported, these data can be reported on a not seasonally adjusted basis as well as a seasonally adjusted basis. Often, the media will report some, or all, of the following:

  1. Index level, not seasonally adjusted. (for example, May 2008 = 216.632).
  2. 12-month percent change, not seasonally adjusted. (for example, May 2007 to May 2008 = 4.2 percent).
  3. 1-month percent change on a seasonally adjusted basis. (for example, from April 2008 to May 2008 = 0.6 percent).
  4. Annual rate of percent change so far this year (for example, from December 2007 to May 2008 if the rate of increase over the first 5 months of the year continued for the full year, after the removal of seasonal influences, the rise would be 4.0 percent).
  5. annual rate based on the latest seasonally adjusted 1-month change. For example, if the rate from April 2008 to May 2008 continued for a full 12 months, then the rise, compounded, would be 8.1 percent.

What index should I use for escalation?

The decision to employ an escalation mechanism, as well as the choice of the most suitable index, is up to the user. When the terms of an escalation contract are drafted, both legal and statistical questions can arise. While BLS cannot help in any matters relating to legal questions, it does provide basic technical and statistical assistance to users who are developing indexing procedures. More.

I am writing an escalation contract tied to annual changes in the CPI. Should I specify a particular monthly index from one year to the next (e.g., December-to-December)? Or should I use CPI annual average indexes?

There is no right or wrong answer to your question. That said, when an escalation contract is tied to the CPI, the index to be used should be spelled out clearly in the contract to avoid potential conflicts, as the Bureau of Labor Statistics cannot mediate disputes which might arise between the parties to an escalation agreement. More information on how to use the CPI in escalation contracts can be found atwww.bls.gov/cpi/cpi1998d.htm.

From a statistical perspective, each of these types of indexes has its advantages. A 12-month percent change from, say, December-to-December, is arguably a more recent estimate of price change than an annual average percent change. Said another way, the December-to-December percent change is the most recent 12-month percent change in a year, while the annual average percent change reflects the change in the average index for all 12 months of one year to the average index for all 12 months the next year.

The December-to-December index percent change, however, tends to be more volatile than the percent change in the annual average index. Annual average indexes are based on 12 monthly data points which, when averaged, reduce volatility by smoothing out the highs and lows. These two types of calculations are explored in greater detail in the report, “Math Calculations…” atwww.bls.gov/cpi/cpimathfs.pdf. To illustrate the differences that can arise between the two methods of calculation, take the situation which occurred in 2008 when the percent changes varied widely between these two approaches, largely as a result of the fluctuating cost of gasoline. The U.S City Average All items index increased just 0.1 percent from December 2007 to December 2008; only five months earlier (from July 2007 to July 2008) this index had risen 5.8 percent. Annual average percent changes for the last few years during this period, on the other hand, have been in a much narrower range.

When should I use seasonally adjusted data?

By using seasonally adjusted data, some users find it easier to see the underlying trend in short-term price changes. It is often difficult to tell from raw (unadjusted) statistics whether developments between any 2 months reflect changing economic conditions or only normal seasonal patterns. Therefore, many economic series, including the CPI, are adjusted to remove the effect of seasonal influences-those which occur at the same time and in about the same magnitude every year. Among these influences are price movements resulting from changing weather conditions, production cycles, changeovers of models, and holidays.

BLS annually reestimates the factors that are used to seasonally adjust CPI data. Seasonally adjusted indexes that have been published earlier are subject to revision for up to 5 years after their original release. Therefore, unadjusted data are more appropriate for escalation purposes.

What area indexes are published and how often?

Besides monthly publication of the national (or U.S. City Average) CPI-U, C-CPI-U, and CPI-W, indexes are published by area for the CPI-U and CPI-W. For the C-CPI-U, data for all items and 27 components are available at the national level only; for the CPI-U and CPI-W, 377 component series are published at the national level. Monthly CPI-U and CPI-W indexes are published for the four census regions: Northeast, Midwest (formerly North Central), South, and West. Monthly indexes also are published for urban areas classified by population size: all metropolitan areas over 1.5 million, metropolitan areas smaller than 1.5 million, and all nonmetropolitan urban areas. Indexes are available as well within each region, cross-classified by area population size. For the Northeast and West, however, indexes for nonmetropolitan areas are not available. BLS also publishes indexes for 27 local areas. These indexes are byproducts of the national CPI program. Each local index has a much smaller sample size than the national or regional indexes and is, therefore, subject to substantially more sampling and other measurement error. As a result, local-area indexes are more volatile than the national or regional indexes, and BLS strongly urges users to consider adopting the national or regional CPIs for use in escalator clauses. Used with caution, local-area CPI data can illustrate and explain the impact of local economic conditions on consumers’ experience with price change. Local-area data are available on the schedule shown below.

BLS publishes three major metropolitan areas monthly:

  • Chicago-Gary-Kenosha, IL-IN-WI
  • Los Angeles-Riverside-Orange County, CA
  • New York-Northern NJ-Long Island, NY-NJ-CT-PA

Data for the following additional 11 metropolitan areas are published every other month [on an odd (January, March, etc.) or even (February, April, etc.) month schedule] for the following areas:

  • Atlanta, GA (even)
  • Boston-Brockton-Nashua, MA-NH-ME-CT (odd)
  • Cleveland-Akron, OH (odd)
  • Dallas-Fort Worth, TX (odd)
  • Detroit-Ann Arbor-Flint, MI (even)
  • Houston-Galveston-Brazoria, TX (even)
  • Miami-Fort Lauderdale, FL (even)
  • Philadelphia-Wilmington-Atlantic City, PA-NJ-DE-MD (even)
  • San Francisco-Oakland-San Jose, CA (even)
  • Seattle-Tacoma-Bremerton, WA (even)
  • Washington-Baltimore, DC-MD-VA-WV (odd)

(Note: The designation even or odd refers to the month during which the area’s price change is measured. Because of the time needed for processing, data are released 2 to 3 weeks into the following month.)

Data are published for another group of 13 metropolitan areas on a semiannual basis. These indexes, which refer to the arithmetic average for the 6-month periods from January through June and July through December, are published with the release of the CPI for July and January, respectively, in August and February for the following areas:

  • Anchorage, AK
  • Cincinnati-Hamilton, OH-KY-IN
  • Denver-Boulder-Greeley, CO
  • Honolulu, HI
  • Kansas City, MO-KS
  • Milwaukee-Racine, WI
  • Minneapolis-St, Paul, MN-WI
  • Pittsburgh, PA
  • Portland-Salem, OR-WA
  • St. Louis, MO-IL
  • San Diego, CA
  • Tampa-St. Petersburg-Clearwater, FL

What area CPI should I use if there is no CPI for the area I live in?

Although the BLS can provide some guidance on this question, users must make the final decision.

As noted in the answers to Questions 14 and 17, BLS strongly urges the use of the national or regional CPIs for use in escalator clauses. These indexes are more stable and subject to less sampling and other measurement error than are area indexes and, therefore, are more statistically reliable.

Can the CPIs for individual areas be used to compare living costs among the areas?

No, an individual area index measures how much prices have changed over a specific period in that particular area; it does not show whether prices or living costs are higher or lower in that area relative to another. In general, the composition of the market basket and the relative prices of goods and services in the market basket during the expenditure base period vary substantially across areas.

What types of data are published?

Many types of data are published as outputs from the CPI program. The most popular are indexes and percent changes. Requested less often are relative importance (or relative expenditure weight) data, base conversion factors (to convert from one CPI reference period to another), seasonal factors (the monthly factors used to convert unadjusted indexes into seasonally adjusted indexes), and average food and energy prices. Index and price change data are available for the U.S. city average (or national average), for various geographic areas (regions and metropolitan areas), for national population-size classes of urban areas, and for cross-classifications of regions and size classes. Indexes for various groupings of items are available for all geographic areas and size classes.

Individual indexes are available for more than 200 items (for example, apples, men’s shirts, and airline fares), and more than 120 different combinations of items (for example, fruits and vegetables, food at home, food and beverages, and “All Items”), at the national (U.S. city average) level. A few indexes are available from as far back as 1913.

Each month, indexes are published along with short-term percent changes, the latest 12-month change, and, at the national item and group level, unadjusted and (where appropriate) seasonally adjusted percent changes (and seasonal factors), together with annualized rates of change. The annualized rates indicate what the rate of change would be for a 12-month period, if a price change measured for a shorter period continued for a full 12 months.

The answer to question 16 provides information about the areas and size classes for which indexes are published. For areas, BLS publishes less detailed groupings of items than it does for the national level. The following lists illustrate this point:

Atlanta, GA
All items

  • Food and beverages
    • Food
      • Food at home
U.S. City Average
All items

  • Food and beverages
    • Food
      • Food at home
        • Cereals and bakery products
          • Cereals and cereal products
            • Flour and prepared flour mixes
            • Breakfast cereal
            • Rice, pasta, and corn meal
              • Rice
          • Bakery products
            • Bread
              • White Bread
              • Other Breads
            • Fresh biscuits, rolls, muffins
            • Cakes, cupcakes, and cookies
              • Cookies
              • Fresh cakes and cupcakes
            • Other bakery products
              • Fresh sweet rolls, coffeecakes, and doughnuts
              • Crackers, bread, and cracker products
              • Frozen and refrigerated bakery products, pies, tarts, turnovers

Annual average indexes and percent changes for these groupings are published at the national and local levels.

Semiannual average indexes and percent changes for some of these groupings are also published.

Each month, BLS publishes average price data for some food items (for the United States and four regions) and for some energy items (for the United States, four regions, three size classes, 10 cross-classifications of regions and size classes, and 14 metropolitan areas).

What are some limitations of the CPI?

The CPI is subject to both limitations in application and limitations in measurement.

Limitations of application

The CPI may not be applicable to all population groups. For example, the CPI-U is designed to measure inflation for the U.S. urban population and thus may not accurately reflect the experience of people living in rural areas. Also, the CPI does not produce official estimates for the rate of inflation experienced by subgroups of the population, such as the elderly or the poor. (BLS does produce and release an experimental index for the elderly population; however, because of the significant limitations of this experimental index, it should be interpreted with caution.)

As noted in the answer to question 19, the CPI cannot be used to measure differences in price levels or living costs between one place and another; it measures only time-to-time changes in each place. A higher index for one area does not necessarily mean that prices are higher there than in another area with a lower index. It merely means that prices have risen faster in the area with the higher index since the two areas’ common reference period.

The CPI cannot be used as a measure of total change in living costs because changes in these costs are affected by (such as social and environmental changes and changes in income taxes) that are beyond the definitional scope of the index and so are excluded.

Boston University Trading Club
Chuhao(Joe) Zhou
wowbu@Bu.edu

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