Understanding the CPI: this metric can help you make better money decisions

Indexes that saw a slight increase in December include the shelter, household furnishings and operations, motor vehicle insurance, recreation, and apparel indexes. Used cars and trucks, and airline fares decreased over the month. This most recent report also ushered in a number of year over year changes, with the energy index increasing 7.3% for the 12 months ending December, and the food index increasing 10.4%. 

What is the consumer price index? 

The consumer price index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The index measures the cost of items like food, gas, electricity, new vehicles, clothing, medical care, shelter, transportation, and more. 

“That ‘basket’ of goods and services is designed to be representative of what households actually spend their money on,” says Matt Kolyar, Economist at Moody’s Analytics. “That spending data is derived from the Consumer Expenditure Survey that the BLS produces annually. For instance, gasoline represents roughly 4% of total spending for the average household. The CPI would give 4% ‘weight’ to gasoline prices. The remainder of the index captures things like rent, food, car payments, insurance, etc. The BLS collects prices of these goods and services each month to calculate changes from the month before.” 

What the CPI can tell you about the economy 

On a macro-level, the CPI serves as an economic indicator. It tells economists and policymakers how the economy is doing and how to best shape policy to adjust for rising costs. One of the ways the Federal Reserve does that is by using one of its monetary policy tools: the federal funds rate. 

“The Federal Reserve is mandated to ensure price stability and the CPI offers a clue about whether they are achieving that mandate,” says Kolyar. “The Federal Reserve’s preferred measure of inflation is the personal consumer expenditures deflator, but the CPI is still given consideration. If inflation is deemed too high, the Federal Reserve has tools to indirectly destroy demand in the economy which will alleviate upward price pressures.” 

It also helps companies make decisions about how to run their businesses, what to spend money on, if it’s a wise time to borrow and expand, or if they should be implementing cost-cutting measures. And the CPI gives everyday consumers a look into how their regular expenses are changing month to month and how it will affect their wallets. 

How should the CPI inform your own money choices  

Checking in on the latest CPI can not only keep you up to date on what’s happening with the economy, but it can help you make more informed decisions about how you manage your own personal finances. 

1. It might play a role in which businesses you’re investing in and how much. While it’s impossible to predict how the market will behave or how a company will perform over time, rising costs can make borrowing more expensive and put greater financial stress on companies you’re invested in or are considering investing in. “For investors, this means that businesses will borrow less. That’s less expansion and investment. This makes as-of-yet unprofitable firms deemed “growth stocks” less attractive. Higher borrowing rates today diminishes the value of future cash flows,” says Kolyar. 
2. It can change your wage, social security payments, government pensions, government assistance, and more. Changes to the CPI can lead to cost of living adjustments (COLA) which impact how much you receive in government benefits or assistance and even lead to changes in state minimum wage rates. Knowing how much you can expect to receive in income, benefits, and payments each month—and how that could change—can help you cover your current costs and better plan for the future. 
3. It can tell you how your budget may change and where to make adjustments. When you’re out shopping for groceries and fail to pay close attention to the price tag on your items, or if you set most of your bills to auto-pay, you could miss minor increases that add up to a significant chunk of your income. “Since the CPI represents all goods and services purchased for consumption by urban households, when the rate of inflation rapidly accelerates, the purchasing power of consumers quickly diminishes. That is, consumers’ dollars cannot buy as much as they once could,” says Justin Begley, Economist at Moody’s Analytics. Keeping tabs on how prices measured in the CPI are changing can help you adjust your budget to account for changing costs and ensure that your finances aren’t thrown off track.