Inflation and the CPI

In short

A friend of mine bought the same loaf of bread for years and swore the price crept up while he wasn't looking. He was right. Inflation is the slow rise in what things cost over time. The government tracks it with the Consumer Price Index, or CPI, which follows the prices of a big basket of everyday goods and services. If you are holding cash or saving for a goal, you can check whether your money is keeping pace by comparing your growth to the CPI. Look up the latest reading on the Bureau of Labor Statistics website, at bls.gov/cpi. Then ask a plain question: did my pay and my savings grow faster than prices did? That one habit tells you more than any headline.

The whole of it

What it is

I once watched an old farmer count the cost of feed, seed, and fuel on the back of a feed sack. He never used the word inflation, but he knew it well. Each year his dollars bought a little less. That slow loss is what we mean by inflation.

Inflation is the general rise in prices across an economy over time. When it runs at a steady pace, each dollar you hold buys less than it did before. Economists call this a loss of purchasing power, which just means what your money can actually buy.

The Consumer Price Index is the tool used to measure it. The Bureau of Labor Statistics, part of the U.S. Department of Labor, publishes it every month. It follows the prices that city households pay for things like food, housing, gas, clothes, and medical care. It is a measuring stick, not a law of nature. It gives us one shared way to talk about how fast prices are moving.

You may notice your own costs don't match the headline. That is normal. The CPI is an average across many households, and your life is your own.

How it works

If you are like most folks, you have felt this at the checkout counter before you ever read a report. The CPI just puts numbers to that feeling.

Here is the idea. The Bureau of Labor Statistics picks a basket of goods and services. It records what that basket costs each month. Each item gets a weight based on how much households spend on it. Housing weighs more than movie tickets, for example, because people spend more on a roof than on a night out.

The bureau turns the basket cost into an index number. It compares the current index to an earlier one. The change between the two, shown as a percent, is the inflation rate. If the index goes from 300 to 309, prices rose 9 points out of 300, which is 3 percent.

There are a few versions of the CPI. The bureau publishes one for all urban consumers, called CPI U, and another for urban wage earners and clerical workers, called CPI W. It also publishes a version that leaves out food and energy, often called core CPI. Food and fuel prices jump around a lot, so core CPI gives a steadier view of the trend.

Some things are tied to the CPI by rule. Social Security cost of living adjustments are calculated using it. Certain tax figures are adjusted for inflation each year too. So the index touches your life even if you never read it.

The numbers, and where to find yours

A neighbor of mine once said he trusted numbers more when he could find them himself. That is a good instinct, and here it is easy to do.

The official source is the Bureau of Labor Statistics. Go to bls.gov/cpi and you will find the latest monthly reading, the yearly change, and the tables behind them. The page shows both the change from last month and the change from the same month a year ago. The yearly change is the one most people mean when they say the inflation rate.

The Federal Reserve, our central bank, watches inflation too. Its stated goal, as it describes on its own website, is an inflation rate of the current figure, which the official source publishes each year over the longer run. It uses a related measure called the PCE price index, which comes from the Bureau of Economic Analysis. The CPI and PCE differ a little in what they count and how they weight it.

To find your own number, list what you spend in a month. Note which costs rose and which held steady. Your personal inflation rate may run higher or lower than the national figure, depending on how much you spend on rent, gas, food, or care.

A worked example

Let me tell you about a woman named Marisol. She teaches school and earns 52,000 dollars a year. She saves 4,000 dollars each year in an account that pays 2 percent interest. She wants to know if she is getting ahead.

Suppose the CPI shows prices rose 3 percent over the past year. Marisol wants to check her raise first. Say her pay went up 2 percent. Her new pay is 52,000 times 1.02, which equals 53,040 dollars. Prices rose 3 percent, so to keep up she would have needed 52,000 times 1.03, which equals 53,560 dollars. She fell short by 53,560 minus 53,040, or 520 dollars in buying power.

Now look at her savings. She has 10,000 dollars in that account at 2 percent. After one year she has 10,000 times 1.02, which equals 10,200 dollars. The same 3 percent price rise means what cost 10,000 dollars a year ago now costs 10,000 times 1.03, which equals 10,300 dollars. Her 10,200 dollars falls 100 dollars short of buying the same things.

Notice what happened. Her balance went up. Her buying power went down. Both are true at once. This gap between the number in the account and what it can buy is why people talk about a real return. A real return is your growth after you subtract inflation. Here it is about 2 percent minus 3 percent, or negative 1 percent.

Marisol did nothing wrong. She simply learned something useful. Now she can ask her school for a fair raise, and she can look at how her savings are set up with clear eyes.

Where it goes wrong

I have made this mistake myself, so let me say it gently. It is easy to read the CPI as a verdict on your own life. It is not.

The first trouble is that the CPI is an average. Your costs may differ a great deal from the basket. A person who drives long distances feels gas prices more. A renter feels rent more. Someone with a paid off home feels it less.

The second trouble is timing. The CPI looks backward. It tells you what prices did, not what they will do. Anyone who claims to know next year's number is guessing.

The third is mixing up a rate with a level. When inflation slows from 5 percent to 3 percent, prices are still rising. They are just rising more slowly. Prices do not fall back to where they were. This confuses many good people.

The fourth is trusting only the headline. Core CPI, energy, food, and shelter can all tell different stories in the same month. Read the tables when you can. The Bureau of Labor Statistics publishes them free.

Last, remember that a measure can be imperfect and still useful. Economists debate how best to count things like quality changes and new products. The bureau explains its methods on its own site if you want to read them. Check the source. Trust, but verify.

Questions to answer before you leave this page

Have you looked up the latest CPI reading on the Bureau of Labor Statistics website, and do you know whether it shows the change from last month or from a year ago? Did your last raise match the rise in prices, and can you show the math with your own pay and the CPI change? If you keep cash in savings, do you know what rate it earns, and how that compares to the yearly inflation figure? Which of your own costs rose fastest this year, and does that match the national number or differ from it? What would you want to change about how you save or ask for pay once you see your real return, the growth left after inflation?