How the Consumer Price Index measures inflation

The Consumer Price Index (CPI) is a key barometer of inflation, used to determine the annual cost-of-living adjustments for Social Security benefits and to adjust federal income tax brackets. Private businesses use it to set prices, adjust wages and forecast expenses.

But what is the CPI exactly — and how is it calculated?

The Consumer Price Index is the chief benchmark economists use to measure inflation, or the broad rise of prices for goods and services.

The U.S. Bureau of Labor Statistics calculates the CPI each month by collecting information on the price consumers pay for a "market basket" of over 90,000 goods and services over time — from supermarket items and clothing to new and used cars, housing and gasoline. Price quotes are collected from more than 23,000 retailers and 8,000 rental units across 75 urban areas.

There are two main CPI reports published each month by the Bureau of Labor Statistics, which include both month-over-month and year-over-year price changes:

• The Consumer Price Index for All Urban Consumers (CPI-U): This index is widely cited in discussions of price changes and inflation. It covers roughly 93% of the U.S. population, but not consumers on farms, institutions or military bases.
  
• The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W): This index is used to determine the annual cost-of-living adjustments to Social Security benefits and adjustments to federal income tax brackets. It incorporates about 29% of the U.S. population.

The CPI weighs certain spending categories more than others, based on what people are spending their money on: The U.S. Bureau of Labor Statistics determines the weight of each spending category by looking at the Consumer Expenditures Survey, which focuses on the spending habits of more than 20,000 consumers from two years prior.

The "services less energy services" category, for example, includes shelter — but also services like car rentals, vet bills and lawn care — and it makes up roughly 56% of the CPI.

The "commodities less food and energy commodities" category, meanwhile, accounts for 21% of the CPI.

The CPI uses an innovative way to measure shelter costs, known as the Shelter Index. It's comprised of four parts.

• Rent: The cost of renting primary residences (about 7-8% of the CPI)
• Owners' equivalent rent (OER): The amount of rent a homeowner would get if they rented out their own home (roughly 27% of the CPI)
• Lodging away from home: Includes hotels, vacation rentals and other costs for staying away from home (1-2%)
• Tenants' and household insurance: Costs for insurance for tenants and households (0.4%)

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