Q&A: What is the consumer price index? An economist explains

UNIVERSTY PARK, Pa. — The U.S. Bureau of Labor Statistics (BLS) released the latest inflation report, based on the U.S. Department of Labor’s consumer price index (CPI), on March 12. The monthly report tells consumers how much more expensive goods and services are, month-to-month and year-to-year. Kenneth Louie, associate professor of economics at Penn State Behrend, explained in the following Q&A what the CPI is and why American consumers should pay attention.

Q: What is the consumer price index? How does the government calculate it?

Louie: The CPI is a number compiled by the BLS and used to measure how the prices of goods and services in the economy change over time. The CPI, which reflects the cost of a representative market basket of goods and services purchased by urban consumers, is perhaps the most widely cited measure of inflation in the U.S. economy. Each month, the BLS publishes the latest CPI, which tells us whether prices in the economy are rising, falling or remaining stable. When the CPI rises continually on a monthly or annual basis, the economy is experiencing inflation.

The “rate of change” in the CPI is a measure of how much, on average, the prices of goods and services are rising. For example, the most recent report released on March 12 showed that the CPI increased by 0.2% on a seasonally adjusted basis — meaning it accounts for and removes predictable seasonal fluctuations, like increased hiring during the winter holidays — from January to February of 2025. It also showed that CPI increased by 2.8% over the last 12 months. Back in June 2022, the U.S. economy experienced a much higher rate of inflation when the CPI rose by 1.3% on a monthly basis and by 9.0% on an annual basis.

The BLS also compiles price information for different categories of commodities such as food, transport, energy and shelter. For example, the prices of meats, poultry, fish and eggs increased by 1.6% from January to February and by 7.7% over the last 12 months.

To calculate the CPI, the BLS gathers data on the prices of goods and services in 75 urban areas across the U.S., from approximately 22,000 retail and service establishments. The BLS also incorporates information on the price of housing — or “shelter” — by gathering data on rent from about 50,000 landlords or tenants. These extensive price data are used to construct the “CPI-U” index number, which measures the cost of purchasing a representative market basket of goods and services by urban consumers covering over 90% of the U.S. population. The representative market basket is based on expenditure information provided by families and individuals regarding their actual purchases and spending habits. Changes in the CPI thus reflect the average change over time in the prices of goods and services in the representative consumption basket. As a result, according to the BLS, “the CPI measures inflation as experienced by consumers in their day-to-day living expenses.”

Q: What does this indicator say about the state of the economy?

Louie: The CPI is one important indicator that we use to gauge the performance and overall health of the economy. For example, a high rate of inflation can be due to excessive aggregate demand for goods and services, suggesting that the economy is “overheated” and possibly needs to be slowed down. A high rate of inflation can also be due to disruptions to the supply of goods and services, suggesting the presence of bottlenecks in the domestic or global production and supply chain that need to be resolved. At times, government economic policies such as excessive fiscal stimulus or substantial loosening of monetary policy can also lead to inflation, suggesting a need to moderate those policies.

Regardless of the cause, a high rate of inflation, with all else constant, can hurt many individuals and families and lead to a gradual weakening of the economy. That’s because a high rate of inflation reduces the real purchasing power of consumers, especially those whose incomes are not increasing commensurately with the rising prices.

It should be noted that, continually falling prices, or deflation, over the long term can also cause harm and weaken the economy. Therefore, the U.S. Federal Reserve strives to maintain a monetary policy stance that produces price stability with a target rate of inflation of 2%.

Q: What should people be watching for with the CPI?

Louie: It’s usually more important to watch the long-term trend in the CPI rather than the change in one specific month. That’s because the demand and supply imbalances that affect prices in the short run may be resolved gradually, thereby eventually lowering the rate of inflation, or they may become more severe, causing even more inflation. Problems associated with inflation are generally more severe when the inflation is persistent over a long period.

For individuals, it is important to watch how changes in the CPI will potentially affect their economic well-being. For example, workers should pay attention to changes in the CPI since inflation can erode their “real” disposable incomes by lowering their purchasing power. Workers whose earnings are not increasing commensurately with the rate of inflation will suffer a reduction in their economic well-being. Similarly, individuals who own interest-yielding assets, such as bank savings accounts, will suffer real losses when the rate of inflation is higher than the nominal interest rate they are receiving from those assets.

Changes in the CPI can affect the economic well-being of individuals in other ways. For example, according to the BLS, “the CPI is used to adjust income eligibility levels for government assistance, federal tax brackets, federally mandated cost of living increases, private sector wage and salary increases, and consumer and commercial rent escalations. Consequently, the CPI directly affects hundreds of millions of Americans.”