The CPI or consumer price Index of a country tracks the prices of a variety of everyday goods and services purchased by households. It typically covers areas like transport, food, clothing and leisure spending. As Kavan Choksi mentions, CPI comprises of a basket of goods and services, and calculates the basket price as a weighted average of the constituent items’ retail prices. Averaging out price changes across a basket of these goods enables economists to work on how prices are falling or rising, and how that impacts the cost of living.
Kavan Choksi briefly marks the importance of the Consumer Price Index
Consumer Price Index or CPI is typically released on a monthly basis. However, quarterly and yearly reports are also common. Periodic release of CPI reports makes it easy to analyse the change in the process of both individual items and the entire basket over a span of time. In the United States, the CPI is calculated by the U.S. Bureau of Labor Statistics or BLS. The BLS releases updated CPI data every month, which shows the monthly and annual changes in average prices.
Consumer Price Index is among the most commonly used tools for measuring deflation and inflation. Inflation is an important indicator of the health of the economy. Central banks and Governments use the CPI and certain other indices in order to make various economic decisions, including whether to raise or lower interest rates. Higher interest rates make borrowing money costlier and are meant to lower consumer spending, and in turn, inflation. Lower interest rates just work the opposite way. They are designed to encourage consumer spending, so as to keep inflation in line with the target of the country.
CPI is even used for guiding wage adjustments in line with the cost of living, and helps measure the eligibility of individuals for benefits like social security. Economists tend to use CPI data for measuring the total value of goods and services produced by an economy with the effect of inflation stripped out. This indicator is known as the Real Gross Domestic Product.
Consumer Price Index is the main economic indicator of inflation and therefore has a vital role to play in the monetary policy decisions of the central bank. The central bank of every country has the responsibility to create a monetary policy that facilitates economic growth. In addition to unemployment rates and GDP, inflation tends to be a key aspect of economic growth. For most countries, the inflation target is generally set between 2% and 3%. The central bank can try to control the inflation rate by using interest rates as a tool. As Kavan Choksi says, interest rate decisions generally top the list of most influential economic events, and have a significant impact on the value of the national currency of a country. As central banks opt to increase or cut the interest rates on the basis of the performance of the inflation rate, CPI reports are closely followed by investors and analysts. These reports may have a major impact on the market sentiment towards the currency and can create large-scale volatility in the financial markets.
