Lesson 68 – How to Interpret the Consumer Price Index (CPI)

Topic Progress:

In our last lesson we looked at the Producer Price Index, an indicator which is
designed to show the fluctuations in prices received by producers for their goods. In this lesson we are going to look at an indicator which is designed to represent increases or decreases in prices paid by the end consumer and can also cause large market movements, the Consumer Price Index.

Released at 8:30 am eastern standard on approximately the 15th of each month, the Consumer Price Index (CPI) is a measure of the changes in prices paid by urban consumers for a fixed basket of goods and services.

Where the Producer Price Index (PPI) which we learned about in our last lesson measures the increase or decrease in the price producers receive for their goods, the Consumer Price Index (CPI) measures the price that consumers pay for those goods.

The question that naturally arises when hearing this is wouldn’t those two numbers be the same or at least move in tandem with one another? The answer to that question is not necessarily, for the following reasons:

  1. The PPI is designed to measure the entire marketed output of US producers which includes goods and services purchased by other producers. (The CPI includes only
    goods purchased by consumers)
  2. Imports are excluded from PPI but included in CPI
  3. Taxes paid as part of the purchasing price by the consumer are not included in PPI but are included in CPI.

The important thing to understand here is that while changes in PPI are normally looked at as having predictive power as to changes in the CPI, a rise or fall in the PPI does not necessarily mean the same rise or fall in the CPI. As this is the case, and as the CPI is the end price paid by the consumer, this number best represents the level of inflation in the US economy.

In addition to showing fluctuations in price for different areas of the country, the CPI also shows the fluctuation in price for different groups of products such as housing, transportation, medical care etc. This allows traders to see not only the price fluctuations of the overall economy but also for different areas of the economy.

There are two main CPI numbers reported which are the CPI for Urban Wage Earners and Clerical Workers (CPI-W) and the CPI for all Urban Consumers (CPI-U) which basically give two separate numbers for the price increases experienced by working people and the price increases experienced by all consumers.

As with the PPI the Consumer Price Index is also presented without volatile food and energy included. This “Core CPI” number or CPI-U minus food and energy is the most widely followed number.

As we have learned in previous lessons, the level of inflation in the economy has a huge effect on the markets, so as the CPI is the primary measure of inflation, fluctuations in this number can create large market volatility as well.

That concludes this lesson. In our next lesson we are going to look at another indicator which has ramifications on both price and growth in the economy and existing home sales.