WASHINGTON, July 25 — The Consumer Price Index is a statistical estimate of the level of prices of goods and services bought for consumption purposes by households. It is calculated as the weighted average price of a market basket of consumer goods and services. Changes in the CPI track changes in prices over time.
The items in the basket are updated periodically to reflect changes in consumer spending habits. Prices of goods and services in the basket are collected, often monthly, from a sample of retail and service establishments.
Prices are then adjusted for changes in quality or features. The annual percentage change in the CPI is used as a measure of inflation. By the numbers, the index is usually computed monthly, or quarterly in some countries, as a weighted average of sub-indices for different components of consumer expenditure, such as food, housing, shoes, and clothing.
Each sub-index is itself a weighted average of sub-sub-indices. At the most detailed level, the elementary aggregate level (for example, men’s shirts sold in department stores in San Francisco), detailed weighting information is unavailable, so indices are computed using an unweighted arithmetic or geometric mean of the prices of the sampled products.
However, the growing use of barcode scanner data is gradually making weighting information available even at the most detailed level. These indices compare prices each month with prices in the price-reference month. The weights used to combine them into higher-level aggregates and then into the overall index relate to the estimated expenditures during the preceding whole year of the consumers covered by the index on the products within its scope in the area covered.
Thus, the index is a fixed-weight index but rarely a true Laspeyres index, because the weight-reference period (a full year) and the price-reference period (usually a single recent month) do not coincide. The CPI can be used to index the real value of wages, salaries, and pensions; to regulate prices; and to deflate monetary magnitudes to show changes in real values. In most countries, the CPI is one of the most closely watched national economic statistics.
There is a large technical economics literature on index formulas that would approximate a true cost-of-living index — showing how consumer expenditure would have to move to compensate for price changes so consumers can maintain a constant standard of living. Those approximations can only be computed retrospectively, whereas the CPI has to appear monthly and preferably quite soon.
Not every country treats the index the same way. In some countries, the philosophy is that the CPI is inspired by and approximates the notion of a true cost-of-living (constant utility) index. In most of Europe, the approach is regarded more pragmatically.
The coverage of the index may be limited. Consumers’ expenditure abroad is usually excluded, and visitors’ expenditure within the country may also be excluded.
Investors will note that CPI remains a statistical estimate — not a perfect measure, but the closest monthly snapshot of how prices are moving across the economy. The figure that matters each month is the annual percentage change, the benchmark that policymakers, markets, and labor negotiators all watch.
