The CPI: The key to understanding economic inflation

The Consumer Price Index, known as CPI, is an essential tool in the world of economics. This indicator plays a crucial role in providing us with a window into the price dynamics of goods and services we consume daily. In this article, we will explore in detail what the CPI is, its fundamental purpose, how it is calculated, and how it is used to measure inflation. In addition, we will unravel the different types of CPI that are used to analyze the evolution of prices in various areas of the economy and what relationship it has with the unemployment rate.

What is the CPI

The Consumer Price Index (CPI) is an essential measure in the world of economics. It is a key indicator that helps governments, businesses and consumers understand and evaluate the evolution of prices of goods and services in a given economy. The CPI provides an overview of inflation and is a fundamental tool in economics that allows us to measure inflation and understand how the prices of goods and services affect people's daily lives and economic stability in general. Its calculation and analysis are crucial for making informed economic decisions.

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Annual evolution of the CPI in Spain. Source: INE.

What is it for

The CPI is used to measure the variation in the price level of a basket of goods and services representative of average consumers. This allows economists, analysts and public policy makers to evaluate inflation, which is the generalized and sustained increase in prices. Inflation can have a significant impact on the economy, as it can erode people's purchasing power and affect overall economic stability. In addition to assessing inflation, the CPI is also used in indexing salaries and contracts, ensuring that adjustments are made in line with rising prices. It is also essential for calculating real Gross Domestic Product (GDP), which is a fundamental measure of economic growth.

How the CPI works

The CPI is calculated through a series of steps:

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Groups that make up the IPC. Source: CaixaBank Blog.

Types of CPI

There are several types of CPI that are used to measure inflation in different segments of the economy or for specific purposes.

Relationship between the CPI and the unemployment rate

In the broadest sense, the CPI and unemployment rates are usually inversely related. This is not always the case in all economies, but the Federal Reserve often attempts to decrease one metric while balancing the other. For example, in response to the COVID-19 pandemic, the Federal Reserve took unprecedented supervisory and regulatory measures to stimulate the economy. As a result, the labor market strengthened and returned to pre-pandemic rates in March 2022; However, this stimulus has led to the highest CPI estimates in decades. As a result of higher-than-expected CPI estimates, the Federal Reserve began raising interest rates and reducing certain asset purchases. On the one hand, these measures aim to slow down economic growth, make it more expensive for consumers to acquire debt and slow the growth of the money supply. On the other hand, these additional expenses can burden households and make businesses less profitable. All things being equal, when the Fed attempts to lower the CPI, it runs the risk of unintentionally increasing unemployment rates.

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Relationship between the inflation rate and the unemployment rate. Source: Economic Help.


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