Consumer Price Index (CPI)

At the start of 2022, the financial markets were surprised when the U.S. government’s Consumer Price Index (CPI) – the most widely used measure of inflation – rose at the fastest pace since 1982.

Inflation is the decline of a currency’s (the U.S. dollar in this case) purchasing power over time. An estimate of the rate at which the decline in purchasing power occurs can be shown in the increase of an average price level of a basket of selected goods and services in an economy over some period of time.

That’s where the Consumer Price Index comes in. So, what is it exactly and why is it so important?

What Is the Consumer Price Index?

The Consumer Price Index (CPI) is a monthly measurement of U.S. prices for household goods and services. The Bureau of Labor Statistics (BLS) computes the CPI by taking the average weighted cost of a basket of goods in a given month and dividing it by the weighted cost of the same basket the previous month. It then multiplies this percentage by 100 to get the number for the index.

The index shows how much prices have changed since the base year of 1982. The CPI was 281.1 in January 2022. That’s how much prices have increased since the base was established at roughly 100.

The basket represents the prices of a cross-section of goods and services commonly bought by urban households. This cross-section represents around 93% of the U.S. population, and it factors in a sample of 14,500 families and 80,000 consumer prices.

These are the major categories in the basket and how much each contributed to the CPI in January 2022: Housing (shelter) – 32%, Commodities (such as autos and medicine) – 21%, Food – 14%, Energy – 7%, Healthcare – 7%, Transportation – 5%, Others – 14%.

Why Is the Consumer Price Index Important?

The CPI plays a role in the lives of many Americans.

First, the CPI is tied to the adjustments made in the cost of living index. That’s important because the cost of living index determines things like annual changes in Social Security benefit amounts and how much money you can contribute to tax-advantaged retirement accounts on a yearly basis. Employers can also use cost of living adjustment data to increase wages paid to employees.

The Consumer Price Index is also important to economists as a tool for measuring how the economy as a whole is faring when it comes to inflation or, on occasion, deflation. 

That is important when you’re planning how to spend or invest your money. It’s always a good idea to have a sense of which way prices are trending. That can help you better plan your budget.

The CPI is also very important because it is a key consideration for the Federal Reserve in setting its interest rate policy, which greatly influences financial markets globally.

The Fed will raise interest rates if it thinks the inflation rate is too high, to slow economic growth. By making loans more expensive, this tightens the money supply—the total amount of credit allowed into the financial system. Slowing growth and demand should put downward pressure on prices.

The longer-term risk for the Fed is falling behind in tightening (raising interest rates). Then it could be forced to play catch-up with a much bigger response – raising rates even higher than would have been needed if action was taken earlier.

How to Hedge Against Inflation

So how can you hedge against inflation?

For example, if the CPI is signaling that a period of inflation may be on the horizon, that should encourage you to make strategic moves to protect your investments. If prices are picking up, you may consider making defensive moves in your portfolio to hedge against inflation. Certain stocks, bonds and commodities or even real estate could benefit from a period of inflation.

Your search for various methods of protection against inflation can be made much easier by using Magnifi, a search-based investing platform that can help match investments to your goals. Magnifi’s AI driven system finds investment suggestions for you based on just a few inputs of your data, such as risk tolerance and investment time horizon.

Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.

The information and data are as March 1, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.