The annual percentage change in the Consumer Price Index is the number most people mean when they talk about inflation. Wages, salaries and pensions are indexed to it. Governments use it to regulate prices. In most countries it is one of the most closely watched national economic statistics.
The index itself is a statistical estimate of what households pay for goods and services they buy to consume. Statisticians price a market basket, take a weighted average, and track how that average moves over time. The basket is revised periodically to match changes in how consumers spend. In Ireland, for example, the 2024 update added air fryers and wireless headphones and dropped digital cameras and landline telephones.
How prices are gathered
Agencies collect prices from a sample of retail and service outlets, often every month. In the United States, the Bureau of Labor Statistics collects them in 75 urban areas, from about 6,000 housing units and roughly 22,000 retail establishments. Most prices come from a personal visit, a phone call, or collection by web or app. Ireland’s Central Statistics Office visits over 1,150 shops and businesses and gathers around 53,000 prices each month, then adds online price data and transaction information from major retailers.
When a sampled item is swapped for one of different quality, compilers may adjust the price so the index shows price change rather than the quality difference.
Weights
Not every item counts equally. Petrol takes a bigger share of household spending than bread, so it carries more weight. In the U.S. index, shelter is the biggest category by far, at nearly a third. Food comes second, followed by energy, largely gasoline.
The index is usually computed monthly, though some countries do it quarterly. It is a weighted average of sub-indices for components such as food, housing, shoes and clothing, and each of those is a weighted average of sub-sub-indices. At the most detailed level, men’s shirts sold in department stores in San Francisco, for instance, there is usually no weighting information. Statisticians use an unweighted average of the sampled prices there. Barcode scanner data is gradually changing that.
The weights come from what consumers spent in the preceding full year, while prices are compared against a single recent reference month. That mismatch is why the index is a fixed-weight index but rarely a true Laspeyres index. Starting with January 2023 data, the BLS said it would update its weights every year, using a single calendar year of spending data from 2021. Before that it updated them every other year.
Limits and criticism
Coverage can be narrow. Consumers’ spending abroad is usually left out, and savings and investment are always excluded.
In the 1990s, Fed Chairman Alan Greenspan told Congress the CPI overstated price increases by between 0.5% and 1.5% a year, and the Senate Finance Committee assembled a group of economists to look into it. Some critics argue a fixed basket ignores substitution: shoppers swap to cheaper goods when one gets expensive. Others say it misses quality gains and takes a long time to pick up new products.
Economists have written at length about index formulas that approximate a true cost-of-living index. Those can only be computed after the fact, while the CPI has to appear monthly and fairly quickly. In the U.S. and Sweden the index is inspired by the cost-of-living idea. Most of Europe takes a more pragmatic view.
The CPI is not a perfect measure of inflation or the cost of living. Month to month, seasonal or temporary factors can move it, which is why news coverage usually leads with the annual change.
Sources
- Consumer price index – Wikipedia
- What is the Consumer Price Index (CPI)?
- Consumer Price Index (CPI): Understanding Inflation's Impact on Your Wallet
