The Consumer Price Index (CPI) is the most widely used measure of inflation in the United States. It measures the change in prices of a basket of goods and services that are commonly purchased by consumers. The CPI is calculated by the Bureau of Labor Statistics (BLS) and is released monthly.
The Consumer Price Index is not a perfect measure of inflation. It has a number of limitations, including:
- It does not account for changes in the quality of goods and services: The CPI assumes that the quality of goods and services remains constant over time. However, this is not always the case. For example, a new car today is much more technologically advanced than a car from 20 years ago. The CPI does not account for this change in quality, which means that it may underestimate the true cost of inflation.
- It does not account for substitution effects: When the price of a good or service increases, consumers may substitute it for a cheaper alternative. For example, if the price of beef increases, consumers may substitute chicken or pork. The CPI does not account for this substitution effect, which means that it may underestimate the true cost of inflation.
- It is not representative of all consumers: The CPI is based on a basket of goods and services that is representative of the spending patterns of a typical urban consumer. However, not all consumers have the same spending patterns. For example, low-income consumers may spend a higher proportion of their income on food and energy, while high-income consumers may spend a higher proportion of their income on housing and transportation. The CPI does not account for these differences in spending patterns, which means that it may not be an accurate measure of inflation for all consumers.
Despite its limitations, the CPI is still the most widely used measure of inflation. It is a useful tool for tracking changes in prices over time and for making comparisons between different periods. However, it is important to be aware of its limitations and to use it with caution.
Here are some alternatives to the CPI that are sometimes used to measure inflation:
- The Personal Consumption Expenditures (PCE) Price Index: The PCE Price Index is also a measure of inflation that is calculated by the BLS. However, the PCE Price Index is based on a broader basket of goods and services than the CPI. This makes the PCE Price Index more representative of the spending patterns of all consumers.
- The Core CPI: The Core CPI is a measure of inflation that excludes food and energy prices. This makes the Core CPI a better measure of inflation that is not affected by volatile food and energy prices.
- The Producer Price Index (PPI): The PPI is a measure of inflation that is calculated for producers. This makes the PPI a better measure of inflation for businesses.
The CPI is calculated in a two-stage process. First, basic indexes are calculated; these are indexes for specific item-area combinations. Ice cream and related products in the Chicago-Naperville-Elgin metro area are an example. These are structured by item category and geographic location. In the second stage, the basic indexes are aggregated into broader indexes, all the way up to the all items U.S. city average index. Thus, the CPI has both a geographic structure and an item structure.
Consumer Price Index Items
Expenditure items are classified in the CPI into more than 200 categories, arranged into 8 major groups. This item structure is unique to the CPI and the categories themselves do not correspond to the North American Industry Classification System (NAICS), other price indexes, or other statistics.
Eight major groups and examples of categories in each follow:
- Food and beverages (breakfast cereal, milk, coffee, chicken, wine, full service meals, snacks)
- Housing (rent of primary residence, owners’ equivalent rent, utilities, bedroom furniture)
- Apparel (men’s shirts and sweaters, women’s dresses, baby clothes, shoes, jewelry)
- Transportation (new vehicles, airline fares, gasoline, motor vehicle insurance)
- Medical care (prescription drugs, medical equipment and supplies, physicians’ services, eyeglasses and eye care, hospital services)
- Recreation (televisions, toys, pets and pet products, sports equipment, park and museum 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)
Additionally, for analytical purposes, the CPI is also divided into food, energy, and all items less food and energy. The CPI for all items less food and energy gets considerable attention as a measure of underlying core inflation, which is not subject to the volatile movements of food and energy prices. A third structure separates the CPI into commodities and services, with commodities further divided into durables and nondurables. All three structures are comprehensive, with the subcomponents in each structure aggregating to the all items index.
It is important to note that there is no perfect measure of inflation. Each measure has its own limitations. It is important to use multiple measures of inflation and to consider the limitations of each measure when making decisions.
Shayne Heffernan
