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Consumer Price Index

The Consumer Price Index more commonly known as CPI, is a figure calculated by the federal government that is used a measure of inflation.

Contents

Expanded Definition

The CPI is a figure well known to many Americans. Essentially it measures how much it costs an average consumer to purchase goods and services he or she needs everyday. The CPI is one of the most widely quoted statistics in the media as a measure of inflation, although it doesn't directly measure increases in the money supply. The CPI take into account changes in prices of a basket of everyday items, weights them in order o perceived importance to consumers and then calculates the average increase. Obviously there is a lot of play in the final number as a result of the weighting and items selected for inclusion.

The CPI's prevalence has allowed it become a benchmark for many things including rent increases in commercial real estate.

Controversy

The CPI is calculate by the U.S. Bureau of Labor Statistics and has frequently come under fire for how it is calucated. The methodology of calculating the CPI has frequently changed over the years to the point that critics argue it no longer accurately tracks inflation. Critics claim that the CPI suffers from "garbage in garbage out" (a phenomenon that says while formulas may be good if the calculator does not give the correct inputs, he or she will not get an accurate number) and that the current formulation excludes too many important items such as bread and milk as well as incorrectly weights others. Furthermore they contend that it's methodology completely ignores substitution effects (where consumers may trade down to less expensive items if an item becomes too pricey), the fact some manufacturers eliminate choice (such as when computer manufactures offer faster computers at the same price as the slower ones that are no longer available for sale) and the method of data collection is haphazard. In order to calculate the CPI BLS employees go periodically around to various retail outlets in a given census area and record prices.

Basically there are a ton of ways this number could be completely wrong.

The CPI's importance to how everyday business is done makes these issues heavily contested.

Inflation can be defined differently for each individual based on your personal spending patterns and your location. The nationally published CPI does not capture this as it is just an average. You can calculate your own personal inflation rate and research inflation data down to the individual item level at http://myinflationrate.com

Importance to Investors

CPI can warn the investor whether we are heading into period of greater than normal inflation or less commonly deflation. The investor can use this information in evaluating companies. The CPI is best considered to be a decent rough estimate of inflation due to the difficulty in calculating it.

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