3 Quick Points to Simplify the Consumer Price Index (CPI)

A widely used metric to measure inflation and deflation

Tunji Onigbanjo

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Photo by Veronika Koroleva on Unsplash

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. The CPI is typically represented as a percentage. Changes in the CPI are used to assess price changes associated with the cost of living. The CPI is one of the most widely used metrics to measure periods of inflation or deflation. The U.S. Bureau of Labor Statistics (BLS) reports the CPI monthly and has calculated it as far back as 1913. The following three points will help to simplify CPI:

1. Understanding Inflation and deflation

2. The Consumer Goods and Services in the CPI Basket

3. The CPI Formula

1. Understanding Inflation and Deflation

Inflation is when the price of goods and services rises, while deflation is when the price of goods and services falls. An increase in the CPI represents inflation when goods and services increase in prices. A decrease in the CPI represents deflation when goods and services fall in pricing. When it comes to the most recent CPI, in November 2021, it rose 0.8% on a seasonally adjusted basis and 6.8% over the last 12 months not seasonally adjusted. With rising CPI, the U.S. is in a period of inflation, and you have likely witnessed it with the rising prices of groceries and gasoline.

2. The Consumer Goods and Services in the CPI Basket

The consumer goods and services used to represent CPI are broken down into the following eight groups: Housing, Apparel, Transportation, Education and Communication, Recreation, Medical Care, Food and Beverages, and Other Goods and Services. When calculating CPI, the BLS includes sales and excise taxes directly associated with the price of goods and services. It is also important to note that the CPI covers professionals, self-employed people, unemployed people, and retired people.

3. The CPI Formula

The CPI formula is as follows: (Cost of Market Basket in Given Year / Cost of Market Basket in Base Year) * 100. When calculating the CPI, the BLS records about 80,000 items each month by calling or visiting retail stores, service establishments, rental units, and doctor’s offices across the country to get the best outlook for CPI.

The CPI is not a perfect metric, but it helps showcase where the U.S. is regarding an inflationary or deflationary period. The U.S. is currently in an inflationary period. If inflation gets to a hyper rate, the Fed will have to step in and increase interest rates and decrease any quantitative easing to reduce the inflationary period. Let me know what you think of the increasing CPI and how the Fed will combat it in 2022.

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