How Inflation Is Measured: The Consumer Price Index
Inflation is usually reported as the yearly change in a consumer price index. Here is how the basket, weights and base year turn thousands of prices into one number.
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Inflation is the rise in the general level of prices over time, and most countries report it using a consumer price index, or CPI. The index follows the cost of a fixed shopping list of goods and services bought by households. When the list costs more than it did a year ago, the percentage difference is the inflation rate. This article explains how that list is built, how prices are gathered and how the final figure is worked out, using the United States Bureau of Labor Statistics (BLS) as the detailed example.
The market basket
A CPI does not track every price in the economy. It tracks a market basket: a sample of the things households buy, such as food, rent, fuel, clothing, medical care and transport. The BLS explains that it sorts spending into more than 200 categories within eight major groups. Each category counts for more or less depending on how much of a typical household's money goes to it. That share is called its weight.
The weights come from household spending surveys. For the 2023 US index, the BLS says it used spending data from 2021, so there is always a lag between what people buy and what the index assumes they buy. In the BLS survey, about 20,000 households were interviewed each quarter, and around 12,000 more kept two-week diaries of frequent purchases such as groceries.
How prices are collected
The BLS describes a multi-stage sample: first geographic areas, then shops and other outlets, then specific products, and for rent, specific homes. Within each category, several hundred specific items are chosen. Collectors record roughly 80,000 prices every month. Food eaten at home and energy are priced monthly. Most other items are priced monthly in New York, Los Angeles and Chicago and every second month elsewhere.
Shops change what they sell. If a chosen item disappears, or comes in a different size or quality, collectors substitute a similar item or record an adjustment for the quality change, so that the index tries to capture a price change rather than a product change. The BLS says about 16 percent of sampled price quotes, excluding rent, came from online sellers as of 2023.
Turning prices into an index
Prices for similar items are first averaged into basic indexes, using a geometric mean formula for most categories since January 1999, according to the BLS. These are then combined using the weights into the overall index. Because the weights come from spending, a 10 percent rise in rent moves the total more than a 10 percent rise in the price of salt.
Wikipedia's overview of consumer price indexes gives the general idea for a single item: divide the current cost by the cost in a base period and multiply by 100. For many items, the index is the weighted sum of the sub-indexes divided by the sum of the weights.
The base period
An index needs a starting point set to 100. Most BLS CPI series use 1982-84 = 100, meaning the average level across 1982, 1983 and 1984 is defined as 100. An index of 110 then means prices are 10 percent above that base period. The absolute number is not meaningful by itself; what matters is how it changes.
Working out the inflation rate
To get inflation, compare the index now with the index a year earlier:
inflation % = (index now - index a year ago) / index a year ago x 100The BLS gives an example: a move from 110 to 128 is 18 index points, which is 16.4 percent. The monthly figure covers the whole month, and the BLS publishes it every month.
- Single month change: compare with the previous month
- Annual inflation: compare with the same month a year earlier
- Seasonally adjusted: removes regular patterns, such as winter heating costs
Real versus nominal money
A CPI can also be used to adjust old money amounts. Dividing a nominal (face-value) amount by the index divided by 100 gives its value in base-period terms, which is how economists compare wages or prices across years. Wages, pensions and some contracts are also tied to a CPI so that their payments keep pace with prices.
What the index does not capture
Wikipedia notes that a CPI is not a perfect measure of inflation or of the cost of living. Adjusting for quality is difficult. Weights stay fixed between updates, so new kinds of spending can take time to appear. Savings, investments and spending abroad are usually left out, and the treatment of owner-occupied housing has long been debated. Methods differ between countries, so rates are not always directly comparable.
Different agencies also revise differently. The BLS says its main indexes are final when issued, while one experimental chained index is revised several times over the following 10 to 12 months. Check the publisher's notes before comparing figures. This is general information, not financial advice.
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