What is the Consumer Price Index and why is it important?

This article was updated in February 2023.

The US Consumer Price Index rose 0.5% in January, increasing 6.4% over the past 12 months. Rising shelter costs and energy were significant contributors, according to the Bureau of Labor Statistics.

But, what are Consumer Price Indices and why do they matter?

A country’s CPI tracks the prices of everyday goods and services that households buy. This covers areas including food, clothing, transport and leisure spending.

By averaging out price changes across a basket of these goods, economists can work out how prices are rising or falling and how this affects the cost of living.

Small items like a loaf of bread or a bus ticket might be part of this basket, alongside larger ones like a car or a holiday, the Bank of England explains.

Most countries update their CPI monthly, apart from Australia and New Zealand, which publish quarterly figures.

Governments have tracked consumer prices for decades. In the United States, the Bureau of Labor Statistics started gathering CPI data in 1913, according to financial website Investopedia.

The Bureau says its data collectors record the prices of about 80,000 items a month across more than 200 categories. This involves visiting – in person or online – or calling thousands of shops and service providers across the US.

The CPI is one of the most commonly used tools to measure inflation and deflation.

Inflation is an important indicator of an economy’s health. Governments and central banks use the CPI and other indices to make economic decisions.

Key among these is whether to raise or lower interest rates. Higher interest rates make borrowing money more expensive and are designed to push down consumer spending – and, in turn, inflation. Lower interest rates work the other way and are designed to encourage consumer spending, to keep inflation in line with a country’s target.

The Consumer Price Index is also used to guide wage adjustments in line with the cost of living, and to measure people’s eligibility for benefits such as social security.

CPI data also helps economists measure the total value of goods and services produced by an economy, with the effect of inflation stripped out – an indicator known as Real Gross Domestic Product.

Consumer prices are soaring at the moment, driven in many countries by rising food and energy costs.

Based on CPI data across its member countries, the Organisation for Economic Co-operation and Development (OECD) recorded a 10.2% jump in consumer prices in July 2022 compared with a year earlier. It marked the first decline in inflation since November 2020 (the June figure was 10.3%), but 15 member states still recorded double-digit inflation.

It rose again though, hitting 10.7% in October, before falling back to 10.3% in November.

Many countries’ central banks have responded by raising interest rates. For example, the United States Federal Reserve increased rates by three-quarters of a percentage point in September and has continued to do so since. Its benchmark overnight rate reached 4.50%-4.75% in January 2023.

Controversies sometimes surface about whether the CPI is a reliable measure of inflation. US economist David Ranson bases his inflation measure on a basket of precious metals instead, because he believes commodity prices are a better and more current indicator of inflation than consumer prices, according to Investopedia.