Consumer Price Index and Colas

The U.S. Consumer Price Index (CPI) is a measure of the average change in the prices paid by consumers living in urban areas for a bundle of consumption goods and services. Average price changes can be driven by changes in consumer income, population and demographic changes, and changes in consumer preferences, as well as by the introduction of new product distribution patterns and marketing techniques. The CPI is updated on a regular basis to respond to such changes. In addition, technological and methodological improvements are introduced into the CPI to improve accuracy.

The CPI is not designed to compare prices between areas. For example, one could say that the prices in Chicago increased by 2 percent from one period to another, while they increased by 5 percent in Washington, D.C. But it would be incorrect to say that prices in Washington, D.C., are higher than they are in Chicago, based on the CPI for these cities.

The official CPI is calculated and published by the Bureau of Labor Statistics (BLS), part of the U.S. Department of Labor. CPIs are published for metropolitan areas in the United States (thirty-eight in 2001), as well as for the four census regions and other areas. National indexes, known as the U.S. City Average, are also produced. Not all indexes are published monthly. Indexes are produced for over 200 basic item categories (for example, bananas, prescription drugs, electricity, women's dresses) and eight major groups or item aggregations. The major groups are food and beverages, housing, apparel, transportation, health care, recreation, education and communication, and other goods and services. The CPI includes government-charged user fees, such as water and sewerage charges, and automobile registration fees, along with taxes such as sales and excise taxes, but excludes income and Social Security taxes. The CPI does not include investment items such as stocks, bonds, real estate, and life insurance. For most of the basic items, the BLS chooses a sample of several hundred specific items within selected business outlets (including stores, mail order firms, and the Internet) frequented by consumers, using scientific sampling procedures, to represent the thousands of items available in the marketplace.

Over time, improvements in the CPI have been introduced. The primary and most visible change has been the introduction of a new "market basket" of goods and services upon which to base the indexes. This market basket is a reflection of what consumers (specifically consumer units, also referred to here as households; consumer units share major expenditures, while a group of people in a household may not) buy; data are collected using household expenditure surveys (also known as consumer expenditure surveys). Shares of total expenditures for items in the market basket are produced from the survey data. Shares are produced over all households within an area, and thus the market basket is considered to be "representative" of the purchases by households within an area. These shares are known as "expenditure weights" or "relative importances," and are attached to prices collected by the BLS to produce the CPI. Consumer expenditures from 1999 to 2000 are used (as of 2002) for expenditure weights for items in every CPI index area. To maintain accuracy, the CPI has historically updated the expenditure patterns approximately every ten years. Beginning in 2002, the expenditure weights are to be updated every two years.

The BLS officially produces an index for two population groups; other indexes are also produced, but are referred to as "experimental." The two official indexes are the Consumer Price Index for All Urban Consumers (CPI-U) and the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-U is based on the experience of consumers living in urban areas of the United States only. This population accounted for about 80 percent of the total U.S. noninstitutionalized population in 1978, when the index was introduced. The CPI-W is a subset of the CPI-U population and is based on the experience of wage earners and clerical workers living in urban areas in the United States. To be included in this population, more than half of the household's income must come from a clerical or wage occupation and at least one of the household's earners must have been employed for at least thirty-seven weeks during the previous twelve months. The CPI-W's population represented about 32 percent of the total U.S. population in 1978.