The Consumer Price Index – usually shortened to CPI – is an important measure of how an economy is performing. Although different countries may use a slightly different formula to calculate their CPI, the basic principle remains the same. By using CPI to measure how much the normal cost of living is increasing or decreasing for citizens, CPI can influence government decisions, benefit and salary levels and more.
Let’s take a look at what CPI is, how it’s calculated, and why it matters so much.
What is the Consumer Price Index (CPI)?
CPI is one way governments and companies measure whether the overall cost of living is going up or down in their location. That gives an indication of the purchasing power of your dollar, pound or euro by showing how far your money will stretch to cover everyday essentials and luxuries.
The Consumer Price Index is calculated by looking at the cost of a predetermined basket of goods and services. These will include common items people buy everyday such as food or clothing, and may also feature bigger purchases like new vehicles and technology. Some countries use a CPI index which includes the costs of housing, education, medical care and transport to ensure a rounded picture.
By measuring the prices of the same set of purchases on a monthly basis, it is possible to see how the costs change over time. This gives insight into what someone needs to spend to maintain a constant standard of living.
CPI is measured slightly differently by different countries. The focus of the measurements is tailored to the country and region the figures are produced for. This may mean the basket of goods and services looks different according to consumption patterns, or that the reporting methods vary somewhat by country.
In the US, CPI figures are produced by the Bureau of Labor Statistics (BLS), while in the UK the Office for National Statistics (ONS) provides monthly updates on CPI.
How is CPI Used?
CPI is used in a range of ways which may impact everyday individuals around the world. By measuring the cost of living, CPI is one measure of inflation, which is important to governments assessing and setting fiscal policies.
CPI is used to calculate the purchasing power of a currency, which matters when determining how much money people need in order to maintain their standard of living. For this reason, CPI can be one factor used to determine changes in benefit payments, pensions, and salaries. It can also be used when calculating levels of tax, to ensure people are not paying more for everyday life at the same time as seeing their taxes rising steeply.
Consumer price index formula
The basket of goods and services used by different countries can vary, and there will be different indexes used for different purposes even in a single country. However, the basic calculation is similar, no matter what the basket looks like:
CPI = cost of basket in current year/cost of basket in base year x 100
The base or reference year used can vary between countries. In the UK, the base year is 2015, while the BLS uses the period 1982 – 1984 for most CPI calculations. In both cases, the base year is shown as 100 – meaning that a percentage swing up will show as a number higher than 100, and a swing down from the value in the base year will be indicated with a number lower than 100.
What is the current CPI rate for 2020?
CPI rates are updated on a monthly basis, and shown in a broad variety of different ways to allow them to be widely used.
In the December 2020 update for the US, the BLS announced that the Consumer Price Index for all Urban Consumers (CPI-U) was up 1.4% before seasonal adjustment, compared to the year prior. The UK’s 12 month rolling CPI was up 0.6% in December 2020, while the calculation which also includes the costs of housing (CPIH) was up 0.8%.
You can find the latest statistics for your part of the world, including breakdowns and background information, online, with a Google search.
What is the difference between the Consumer Price Index and inflation?
CPI is often used as a measure of inflation in a country or region. However, it’s not the only available measure. Depending on what you need the information for, you might find there’s a better index to use.
CPI shows the cost of maintaining consumer purchases at the same level. It’s therefore very useful for companies setting salaries, or governments when deciding on the levels of pension or social security payments. However, other measures exist, such as the Producer Price Index (PPI) in the US, which measures costs of raw goods before they become consumer products, If you’re a manufacturer, this may be a more useful measure of your costs than the CPI, for example.
If you’re an entrepreneur, business owner or freelancer, Wise for business can help you save on the costs of managing your money, and grow your business profits. With a free online Wise account, you can hold, send and spend dozens of different currencies. You’ll get your own local bank details for major regions including the US, UK, euro area, Australia and New Zealand, so you can get paid like a local when you do business there. You could also settle international supplier invoices with Wise for much cheaper than using your regular bank. Wise for business accounts have no monthly fee, no minimum balance and no hidden fees. As well as simple, low cost international payments, you’ll get a linked business debit card and smart features like Xero integration and batch payment facilities. See if you can grow your business with Wise, today.Wise for business
CPI is one measure that impacts people very broadly – despite being rarely understood. From the amount in your paycheck, to the approach the government takes to spending, taxation and broad policy adjustments, CPI can make a difference. If this simple guide has got you interested, you can also learn more – and keep up with trends as they happen – online using the resources available from your local authorities.
