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Consumer Price Index (CPI): What Is It and Why Is It Important?

Everybody is talking about CPI, so let's dive in to learn more about it!

By Bitcoin RealmPublished 5 months ago 5 min read

CPI stands for Consumer Price Index, which is a common indicator for measuring the change in prices paid by the consumers within a country. CPI is usually released regularly by the government or band it calculates the percentage change in the cost of purchasing representative goods and services by surveying the prices of a certain quantity of these goods and services.

For example, if a cup of coffee cost $1.00 last year, but today it has been raised to $1.50, CPI will take into account for the change in price difference.

Generally, CPI is calculated based on the average prices within a certain period, which could be a month, a quarter, or a year. As CPI is one of the important indicators for assessing the inflation rate of an economy, it has received special attention, especially when the US has hit a new high in inflation.

What is the formula for calculating CPI?

The simple formula for calculating CPI is as follows:

CPI = (Total price of goods and services in the current period ÷ Total price of goods and services in the base period) × 100

The base period is a reference point, which is usually set as 100. The result of CPI represents the percentage change of the price of goods and services in the current period compared to the base period.

To be specific, the calculation of CPI requires selecting a basket of representative goods and services that covers food, housing, transportation, healthcare, education, entertainment, and other consumer goods and services, and compute them based on their respective weights. Although the formula and method of calculating CPI may vary in different countries or regions, the basic principles are generally the same.

2023 US CPI Latest Weight Changes

It is noteworthy that the US Department of Labor announced at the beginning of the year that significant adjustments have been made to the CPI weight calculation methods (previously updated every two years, now updated every year) starting from January this year. The changes in the 2023 US CPI weights are as follows:

  • Housing: 44.4% (+2%)
  • Entertainment: 5.4% (+0.3%)
  • Food: 14.4% (+0.1%)
  • Clothing: 2.5% (no change)
  • Other Goods and Services: 2.7% (-0.1%)
  • Medical Care: 8.1% (-0.4%)
  • Education and Communication: 5.8% (-0.6%)
  • Transportation: 16.7% (-1.4%)

Why Change CPI Weightings Annually?

The US Department of Labor stated in the announcement that in the past, the CPI weightings were adjusted every two years, but the adjustment of the weights would have a lag of 36 months. For example, the consumption data from 2019 to 2020 will only be used to calculate adjustments from January 2022 to December 2023 after data collection and processing.

Starting from January 2023, the US Department of Labor will update the CPI weightings every year, shortening the lag period for adjusting the weights to 24 months. This means that in 2023, the weightings that were originally calculated based on consumption data from 2019 to 2020 will be recalculated based on the consumption data from 2021.

Through this adjustment, the US Department of Labor stated that inflation data will be closer to reality, and the CPI weightings will be closer to the actual consumption behavior of modern consumers, thus improving the accuracy of CPI data.

What is the impact of CPI on the stock market?

The CPI index is one of the economic indicators that the market pays great attention to, especially in the current background where the Federal Reserve (Fed) is committed to fighting high inflation. If CPI continues to decline, it means that the Fed's monetary tightening policy is effective, and prices will continue to fall.

On the contrary, if the CPI index remains high, it means that the Fed may need to further tighten its monetary policy. If it chooses to raise interest rates further, funds may flow out of the risky investment market more quickly, which is usually not welcomed by cryptocurrencies and the stock market.

However, changes in the CPI index are not the only factors affecting the market. Prices are influenced by factors such as corporate performance, government policies, geopolitical risks, etc. Therefore, investors need to consider various factors comprehensively to formulate investment strategies.

What is Core CPI?

Another thing worth noting is that when calculating CPI, prices that are more volatile, such as energy and food prices, are excluded, and core CPI can be obtained. (Because the volatility of energy and food prices is higher, they are often affected by factors such as season, weather, natural disasters, etc., while core CPI can better reflect the overall trend of inflation.)

The core CPI in the United States recorded a year-on-year increase of 5.6% in March, slightly higher than 5.5% in February. Therefore, although US inflation is steadily cooling down, there is still a way to go.

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About the Creator

Bitcoin Realm

Crypto | Finance | Investing

I'm a crypto enthusiasts who loves blockchain technology because I believe that the future of finance will become more decentralized. Follow me and share your opinions so that we can discuss and grow more.

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