You've probably heard of the Consumer Price Index (CPI), even if you don't know exactly what it means. Especially in inflationary times, the Consumer Price Index is a popular talking point in the business media since it's used as a proxy for inflation and has a direct impact on the daily lives of consumers.
Keep reading to learn more about what the Consumer Price Index is and how it affects the economy and your budget.
What is the Consumer Price Index?
What is the Consumer Price Index?
In the U.S., the Consumer Price Index is a measurement by the Bureau of Labor Statistics of the average change in the prices paid by urban consumers for a basket of goods and services, including shelter, food, gasoline, utilities, automobiles, and products sold in stores, among other things.
There is more than one Consumer Price Index, but the CPI-U (for urban consumers) is the one that is generally referenced in the media and by economists and is used to make decisions.
What should you know about the CPI?
What should you know about the CPI?
The Consumer Price Index report comes out monthly, usually around the 10th of the month.
There are two growth rates that the index tracks: the month-over-month reading and the year-over-year reading, or how much consumer prices have gone up in the last month and last year.
Media outlets tend to report the monthly figure, although that can be confusing or misleading since they don't always specify that the figure is just for one month.
You should also be aware of the Core Consumer Price Index, which strips out more volatile categories like food and energy, which can swing from month to month since they're based on commodity prices. Some economists prefer to use the Core CPI to understand changes in consumer prices since core changes are more lasting.
The CPI isn't the only tool for measuring inflation. There's also the Producer Price Index (PPI), which measures prices at the wholesale level, and the Personal Consumption Expenditures Price Index (PCE), which is the Federal Reserve's preferred inflation gauge.
Why does the CPI matter?
Why does the CPI matter?
The Consumer Price Index is one of the most influential pieces of economic data for two main reasons.
First, the Consumer Price Index determines the cost-of-living adjustment (COLA) for Social Security each year. The increase in Social Security payments is based on the CPI-W, which is a subset of the CPI-U and is called the Consumer Price Index for Urban Wage Earners and Clerical Workers.
The CPI is also used to determine other price and wage increases, including government salaries, rents, and thresholds for government assistance.
The second major way the Consumer Price Index affects the economy is its effect on monetary policy. The Federal Reserve is charged with the goal of maintaining an inflation rate near 2%. The Fed raised benchmark interest rates substantially to fight high levels of inflation in 2022, leading to higher borrowing rates for everything from mortgages to auto loans and prompting a potential economic slowdown.
Higher rates also caused the stock market to decline in 2022 since higher rates tend to lower stock valuations by making fixed-income investments like bonds more attractive.
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How the CPI can move markets
How the CPI can move markets
One example of how the Consumer Price Index can affect markets happened in November 2022, when the October CPI showed that price growth was softening more than expected. Investors sent stocks soaring on the news, with the Dow Jones Industrial Average gaining 1,200 points as it reassured investors that the Fed was winning its fight against inflation.
At the time, investors were worried that the Fed would keep aggressively hiking interest rates to reel in inflation, but the report helped mark the end of a series of 75-basis-point rate hikes since it showed inflation was falling.
Stocks were bouncing back in 2023, signaling perhaps the start of a new bull market. While the CPI isn't as much of a market-mover as it was in the fall of 2022, it's still worth keeping an eye on it for insight into where the economy and the stock market might be headed.
