How CPI Inflation Is Measured: A Plain-English Guide

CPI inflation is the rate at which the prices consumers pay for a fixed set of goods and services change over time. The Consumer Price Index, or CPI, is produced by the Bureau of Labor Statistics (BLS), part of the U.S. Department of Labor. When a news report says inflation was running at some annual rate, it is usually describing the percentage change in the CPI compared with the same month a year earlier.

The index does not track the price of any one product. It follows the cost of a representative basket of purchases and asks a narrow question: how much would it cost today to buy what households typically bought in an earlier period? That framing explains most of what follows, including why the number can differ from the price increases individual households feel.

In brief

• The CPI is built from tens of thousands of price quotes collected every month across the country.
• Spending weights come from a household survey, so items families spend more on count for more.
• Housing is measured through rent and an estimate of what owners would pay to rent their homes.
• The headline index includes food and energy; the “core” index leaves them out.
• The CPI is a measure of price change for an average urban household, not a personal cost-of-living figure.

What the CPI measures

The BLS describes the CPI as the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The basket covers more than 200 categories, grouped into eight major groups such as food and beverages, housing, apparel, transportation and medical care. Sales and excise taxes and user fees are counted because consumers pay them. Income taxes and investments such as stocks and bonds are not, since they are not purchases of consumer goods and services.

Two versions of the index are widely used. The CPI for All Urban Consumers (CPI-U) covers households in urban areas, which the BLS says represents more than 90 percent of the U.S. population. The CPI for Urban Wage Earners and Clerical Workers (CPI-W) covers a narrower group, roughly 30 percent of the population, made up of households whose income comes mainly from clerical or wage occupations. It leaves out professionals, the self-employed, part-time workers, the unemployed and retirees. News coverage almost always refers to the CPI-U unless it says otherwise. The CPI-W matters because it has historically been tied to cost-of-living adjustments in some federal programs, so check the program’s own rules for the exact index used.

How the basket and weights are set

A price index needs weights. A 10 percent rise in the price of something a household buys every week should matter more than a 10 percent rise in something it buys once a decade. The BLS builds its weights from the Consumer Expenditure Surveys, which collect information about what households actually spend, using quarterly interviews and two-week diaries for frequently bought items.

There is a lag built in. The BLS notes, for example, that weights used for a given year’s CPI were based on expenditure data from two years earlier. The weights are updated on a regular schedule, and the BLS publishes the current relative importance of each category on its website, which lets readers see how much housing, food or transportation contributes to the overall index.

How prices are collected

Collecting prices is a large field operation. The BLS first selects geographic areas, then uses expenditure data to identify the stores and other outlets where residents of those areas shop. Within each outlet, data collectors select specific items, with the chance of selection tied to the item’s share of the outlet’s sales in its category. The result is a sample designed to represent what people buy and where they buy it.

According to the BLS, data collectors gather roughly 80,000 prices each month, in person, online or by phone. Prices for many items are collected across the month rather than on a single day, and depending on the item and the area, a price is collected monthly or every other month. Online outlets are part of the sample: the BLS reported that about 16 percent of non-rent quotes came from them in the year it cited.

Within most item categories, the BLS averages prices with a geometric mean formula. The reason is behavioral: when one product gets more expensive, shoppers often switch to a close substitute. A geometric mean lets the index reflect some of that switching inside a category, rather than assuming shoppers keep buying the same thing no matter what happens to its price. Across categories, the index is weighted by spending patterns.

Housing: rent and owners’ equivalent rent

Shelter is the largest single component in the CPI, and it is measured in a way that surprises many readers. The index does not use home purchase prices. Instead, the BLS treats housing as a flow of services consumed each month. For renters, it tracks what they pay in rent. For homeowners, it uses owners’ equivalent rent (OER), an estimate of what the owner would have to pay to rent their home. The BLS says property taxes are reflected indirectly, to the extent that they influence rental values.

This design has practical consequences. Because rent changes tend to move gradually, as leases renew, shelter in the CPI often responds to the housing market with a delay. A change in mortgage rates or home prices does not show up in the index directly. Analysts who watch inflation therefore pay close attention to the shelter line, since it can keep the headline number elevated or pull it down after other categories have turned.

Quality changes and new products

Prices are only comparable if the product is the same. When an item disappears from a store, or its size or features change, the BLS either records the change or selects a replacement and makes an adjustment. Commodity specialists review the data and adjust for differences in size or quality, so that an improvement in the product is not counted as a price increase. The goal is to separate pure price change from a change in what the consumer is getting.

Quality adjustment is among the more debated parts of the methodology, because it requires judgment, especially for products that change quickly. The BLS documents its methods in its handbook of methods and technical notes, and readers who want detail on a specific category, such as apparel, new vehicles or medical care, can find it there.

Seasonal adjustment and the monthly number

Many prices follow a calendar: clothing changes with the seasons, fuel prices shift with driving patterns and holidays affect travel costs. To show the underlying trend, the BLS publishes seasonally adjusted series that remove recurring seasonal effects. It re-estimates the seasonal factors each year, and seasonally adjusted data can be revised for up to five years. Not seasonally adjusted data are not revised in this way, which is why the BLS generally recommends them for contracts and escalation clauses.

So the monthly CPI release usually contains two kinds of numbers. The month-over-month change is typically quoted on a seasonally adjusted basis. The year-over-year change is typically quoted on an unadjusted basis. Mixing them up is a common source of confusion when a headline and a chart seem to disagree.

Headline versus core

The headline CPI covers everything in the basket. The “core” CPI, formally the index for all items less food and energy, removes two categories whose prices can swing sharply because of weather, geopolitical events and commodity markets. The BLS publishes the index but does not set a formal definition of “underlying inflation.” It notes that some users focus on this measure because they want to see the underlying rate of inflation without those volatile components. Core inflation has its own limits, since food and energy are real costs that households pay, and for many families they are a large part of the budget.

What the CPI does and does not tell you

The CPI is a measure of average price change for a fixed basket. It does not measure the cost of living of any particular household, and it does not capture every way people experience price changes. A retiree who spends heavily on medical care, a young renter in a high-cost city and a rural commuter who drives long distances can each face a different inflation rate than the national figure.

Several other points are worth keeping in mind:

• The index covers out-of-pocket consumer spending, not business costs or government purchases.
• Percent changes are rates of change in an index level. When the level rises from 300 to 306, for example, the index has risen 2 percent.
• Revisions are limited. Unlike many economic series, the unadjusted CPI is generally not revised after publication.
• Sampling means that each month’s figure carries some statistical error. The BLS publishes information on the reliability of its estimates.

A worked example

Suppose a simplified basket has two items. Housing makes up 60 percent of a household’s spending and food makes up 40 percent. Over a year, housing costs rise 4 percent and food costs rise 2 percent. The weighted change is 0.6 times 4 plus 0.4 times 2, or 3.2 percent. If the household also stopped buying a pricier food and switched to a cheaper one, a geometric mean within the food category would register a smaller food increase than a simple average would. The real index does this across more than 200 categories and thousands of items, but the logic is the same.

Where to find the data

The BLS publishes each CPI release on bls.gov, with detailed tables by category and region, and a calendar of upcoming release dates. The release tables show monthly and 12-month changes and the relative importance of each component. The BLS also provides a CPI inflation calculator and a database of historical series, so readers can look up the index for a specific item or metropolitan area.

FAQ

Is the CPI the same as the inflation rate?

The CPI is the most widely cited measure of consumer inflation, and the inflation rate usually refers to its percentage change. It is one of several measures. The Federal Reserve’s stated 2 percent goal is framed in terms of a different index, the PCE price index, produced by the Bureau of Economic Analysis.

Why does my own inflation differ from the CPI?

The CPI tracks an average basket for urban consumers. Your spending mix, location and habits differ from the average, so your personal rate can be higher or lower.

Does the CPI include home prices?

No. It measures shelter through rent and owners’ equivalent rent, not the price of buying a home. Home purchase prices and mortgage interest are not directly part of the index.

How often is the CPI released?

The BLS releases the CPI monthly. Check the BLS release schedule for exact dates, since they vary from month to month.

Is the CPI revised?

Seasonally adjusted figures are revised for several years as seasonal factors are re-estimated. The not seasonally adjusted index is generally not revised.

What is the difference between CPI-U and CPI-W?

The CPI-U covers urban households and represents over 90 percent of the population. The CPI-W covers a subset of about 30 percent, based on households with wage and clerical earners.