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Friday, June 22, 2007

What exactly is the Consumer Price Index?

Non-economists hear about the CPI on a monthly or quarterly basis, often in the context of bad news concerning inflation or perhaps the "good" news concerning a cost of living adjustment. My hunch is that many non-economists are not really familiar with what the CPI is, how it is measured, constructed, and adjusted.

Evidently the good folks at the Congressional Budget Office feel the same because they released this brief concerning the CPI:
The consumer price index for all urban consumers (CPI-U) is the best-known official measure of inflation. Published monthly by the federal Bureau of Labor Statistics (BLS), the CPI-U tries to approximate changes in the cost of living–that is, changes in the cost of maintaining a constant standard of living from one month to the next. To construct the CPI-U, BLS surveys the prices of thousands of goods and services (the index has more than 200 categories of items) in 38 regions, averaging the results to form a nationwide estimate of inflation. Over the past five years, the cost of living, as measured by the CPI-U, has varied but, on average, has risen by about 2-3/4 percent per year.

The purpose of this brief is to explain some of the methods used to construct the CPI-U and why, in some cases, the index's estimates of inflation may differ from consumers' perceptions of how much prices are rising. The brief focuses on six aspects of the CPI-U's construction: averaging regional price indexes to create a nationwide index; estimating the expenditure weights that BLS assigns to the major categories of prices in the CPI-U to account for the categories' relative importance; allowing for shifts in relative prices, a phenomenon known as economic substitution; adjusting for changes in the quality of various goods and services; measuring prices for medical care; and measuring prices for shelter.
I think that sometimes we economists forget that the rest of the world doesn't necessarily speak our language and isn't as comfortable with the figures that we see and digest on a regular basis.

Whether this particular document conveys to the non-economist, and especially the non-numerate, what the CPI is and how it's calculated is not clear to me...

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