Consumer Price Index: What It Is and Why It Matters - NerdWallet (2024)

The consumer price index, or CPI, measures the change in average prices paid by consumers for a set of goods and services that represent regular expenses, like groceries or gas.

The CPI is calculated by the U.S. Bureau of Labor Statistics and is used as a proxy for inflation. Every month, the BLS releases updated CPI data, showing monthly and annual changes in average prices.

Why does CPI matter?

As a measure of inflation, the CPI is one indicator of how the U.S. economy is doing. Monetary policymakers consider a low, stable inflation rate to be the mark of a healthy economy. The Federal Reserve targets a 2% annual inflation rate because it encourages businesses and consumers to continue spending, saving, borrowing and investing.

When prices rise sharply, it can mean that the economy is overheated, with too much demand for or too little supply of goods and services. That’s what happened recently. The CPI started to rise above normal levels during the pandemic until it peaked in June 2022 at about 9%.

When prices rise too slowly — or if they’re falling on a large scale — it can mean that the economy is weak, with too little demand or too much supply.

Each of those economic scenarios would be characterized as unhealthy because unstable pricing can have ripple effects on other aspects of the economy, like spending and employment.

In 2022, the Fed took steps to slow inflation by increasing the federal funds rate, making it more expensive to borrow money, and, subsequently, reducing demand. Now that inflation is slowing down, the Fed is looking at cutting rates.

Other uses for the CPI

Private employers may use the CPI to determine how much to pay workers. The federal government also uses the index to reset eligibility levels for government assistance programs, federal tax brackets and cost-of-living increases. For example, the Social Security Administration announced in October the biggest cost-of-living increase in 40 years. SSA bases its annual adjustment on the CPI.

Additionally, anyone can use the index to calculate buying power by adjusting historical values to see how they stack up in today’s dollars. For example, in 1972, median household income was $11,120, according to the U.S. Census Bureau. Factoring in inflation, that income had the same buying power as $85,102 in July 2024, according to the CPI inflation calculator on the BLS website.

How is CPI calculated?

To calculate the CPI, the bureau collects more than 80,000 prices per month from sellers and retailers in 75 urban areas. The price data captures the spending patterns of various populations.

The most commonly cited version of the index is the Consumer Price Index for All Urban Consumers (CPI-U), which shows the change in prices for the average household living in U.S. cities. The CPI-U represents more than 90% of U.S. consumers, making it the most broadly applicable.

The BLS groups goods and services into categories, such as food, shelter, energy and medical care services. Average prices for each item are aggregated and used to calculate the CPI with complex statistics. Everything included in the index is mathematically weighted so that each item or category’s effect on the index reflects its relative importance to consumers. The table below shows the relative importance assigned to some categories in the most recent CPI report.

As an index, the CPI shows where current average prices for a particular basket of goods and services land on a scale relative to a historic reference point. But it’s more common to talk about the CPI’s inflation rate, which illustrates how much prices have increased between two points in time (or decreased, in the event of deflation).

That rate is calculated by determining the current index value of the basket of goods and services, then dividing it by the value of those same goods and services from a year or month prior. The result is then multiplied by 100.

Typically, you’ll see the inflation rate reported for all items included in the CPI. But it's also common to see it reported without energy or food price changes, because those categories tend to be more volatile. This version of the index is known as “core inflation.”

What happened to CPI in August?

The CPI increased 0.2% between July and August, which means prices ticked up, on average, from month to month. Over the past 12 months, the CPI increased 2.5% — the smallest annual inflation rate reported since February 2021.

Core CPI — a measure that excludes food and energy prices — rose 0.3% over the last month and 3.2% over the past 12 months.

Here’s a look at the CPI’s biggest indexes:

CPI vs. PPI

The producer price index, or PPI, also is a measure of inflation calculated by the BLS. However, the PPI focuses on the change in prices from the seller’s point of view, taking into account how much sellers pay producers for their goods.

This index tracks average price changes for domestically produced goods, services and construction.

CPI vs. PCE

Like the CPI, the personal consumption expenditures, or PCE, is a price index that measures changes in how much consumers pay for goods and services. However, the PCE price index is calculated by a separate federal agency called the Bureau of Economic Analysis.

The two indexes also have different scopes. Unlike the CPI, the PCE includes spending done on behalf of consumers.

One common example is medical spending. The CPI takes into account only what a household spends out of pocket on medical care. The PCE price index records that spending as well and adds what employers or government programs pay on consumers’ behalf through insurance plans.

Because the PCE and CPI differ in their formula, weighting, scope and other effects, their results are different. The Federal Reserve prefers to use the PCE price index to measure inflation. This comes into play when the Fed makes monetary policy decisions, such as whether to raise the fed rate.

Next CPI report