What is the Consumer Price Index?

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What is the Consumer Price Index?

Rounding it up

  • The Consumer Price Index (CPI) is a measure of the cost of a virtual basket of goods expressed as a percentage when compared to the same time in the previous year.

  • The CPI helps the government determine if they are meeting their inflation goals.

  • By understanding how CPI works, you can see how the economy is fairing and get an advanced look at if the prices for goods will fundamentally change soon.

5 min read

Dan Bucherer
#consumer price index#CPI#economy

You’ve got to buy stuff. Dinner for tomorrow, gasoline to get to work, electricity to power your home. You’ve got to buy all of it, and the government, believe it or not, wants to know what you’re buying and how much it costs. This isn’t some conspiracy theory, big-brother kind of thing. They want to know how much certain goods cost because it helps them gauge the health of the economy.

When ordinary consumers are able to purchase different items and are generally happy to be doing so (as seen by volume), the economy tends to be good. When folks are buying less over a sustained period of time, it's a good bet that the economy isn’t doing so great. The government uses certain measures to determine how prices affect how consumers are spending their money. This measurement is known as the consumer price index, or CPI. Let’s dive in a bit and understand the history behind this number and exactly what it does.

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What is the Consumer Price Index?

The Consumer Price Index is an incredibly important measure of the health of an economy. Nearly every developed nation has one and many of them are based and benchmarked against the American CPI. And while it may sound complicated (words like “index” tend to have that type of effect), it’s actually quite simple.

The CPI is a measure of the weighted average of a number of different goods over a set period of time expressed as a percentage increase. These goods include things like food, transportation, medical care, and natural resources like metals, timber, and stone. In Canada, the CPI is expressed as a number in US dollars; doing so makes it easier for comparison to other markets. In practice, the CPI helps the government understand how much consumers are paying for certain items and thereby, how strong the economy is. The CPI is also used as an analog for the success or failure of the government’s economic policies.

How does it work?

Each month, the Bank of Canada and Statistics Canada work together to fill a “virtual shopping cart” with items. These items can be anything, from food and rent to cleaning supplies and recreational cannabis. Here’s the full list:

  • Food (groceries and restaurant meals)

  • Shelter (rent and mortgage costs, insurance, repairs and maintenance, taxes, utilities)

  • Transportation (vehicles, gasoline, car insurance, repairs and maintenance, public transit costs)

  • Household expenses (phones, internet, child care, cleaning supplies)

  • Furniture and appliances

  • Apparel (clothing, footwear, jewelry, dry cleaning)

  • Medical and personal care (prescriptions, dental care, eye care, haircuts, toiletries)

  • Sports, travel, education, and leisure

  • Alcohol, tobacco, and recreational cannabis

A healthy chunk of these items likely appears in your weekly or monthly budget. There are more than 700 different items included in the index and they are pulled from things that Canadians most frequently purchase. Every single item in the basket is given a weight based upon the percentage of Canadians that buy that item. For example, while many Canadians use tobacco, it is certainly way less than the number of Canadians that buy food. The weighing allows the government to get an accurate reading.

You can probably see what’s coming next. If the price of one of the items with a higher weight fluctuates, the CPI will change more dramatically. Each month, the Government of Canada will take a look at the prices of the basket of goods and measure how much the price increased in 12 months. For example, the May 2021 CPI was 3.6% and it was measured against the same month in 2020, meaning the price of the same basket of goods increased by 3.6% from May 2020 to May 2021.

The Bank of Canada also measures an annual average, which is an average of the 12 months from January to December. The annual CPI for 2021 thus far (through June) is 137, an increase of .7%.

Now you, internet sleuth, may be saying to yourself, “all well and good, but that has to start somewhere right?” Sure does! The Bank of Canada uses a base year from which to calculate the rise and fall of the CPI. In this case, it uses 2002 as its base with the number of 100. So if the basket of goods in question was worth $100 in 2002 but is now worth $135, that $35 represents inflation.

Having a hard time wrapping your head around how it works? You can use the Bank’s inflation calculator to do a few experiments on your own and calculate the CPI. The calculator can go back as far as 1914 and can reveal some pretty surprising finds. A basket of goods that cost $100 in 1914 would cost $2,389.83 in 2021. Wow!

The Bank has announced that they want to keep inflation at a target of 2% per year. They’ll use the CPI to help them gauge how well this strategy is working and if they need to do anything to either coax inflation up a bit or cool the economy down. They can do this by changing the rate at which they lend money to financial institutions.

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How does the CPI keep up with the times?

Very good question, dear reader. The products in the CPI have changed over time but the overall categories have not. Statistics Canada updates the products contained in the CPI calculation every two years. There are also a number of different things that can affect the CPI and how accurately it represents the economic power of Canadians and the overall economy.

First, the CPI doesn’t take into account when Canadians decide to swap products. There could be any number of reasons for this, but if Canadians suddenly decide to eat more fish as opposed to pork, the CPI doesn’t take this shift into account. Second, because the government only updates the products every two years, they often miss out on the newest products. Third, the quality of products tends to change drastically over the course of many years. This can drive down cost while providing a better product. Finally, online shopping has put an odd dent in the CPI. Because online products tend to be cheaper than those found in stores, the CPI can be off a bit.

The Consumer Price Index may seem like one of those boring, dusty government reports that you don’t need to pay attention to. You should, however, take a passing glance or listen when you hear the abbreviation CPI come up. The CPI gives the government, and ultimately you, a good idea about how healthy the economy is and the kinds of prices you can reasonably expect in the future. By understanding how inflation and CPI work, you can be better prepared to manage your financial life.

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Dan Bucherer

Dan is a runner and writer living in the Washington, D.C. area, where he currently works for a financial services trade association as the Communications Director.

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