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The consumer price index (CPI) is a measurement that governments use to estimate inflation and price levels across their economies. Governments do this by establishing a collection of goods whose prices they will monitor, and then produce a number that represents how the cost of living has gone up or down relative to previous years. Central banks can use their national CPI to judge inflationary tendencies in the economy.
Every government uses a different collection of goods and services, also known as a basket of consumer goods and services, from which to calculate its national CPI. This basket is supposed to offer a picture of the products every citizen uses in the course of living, such as food and housing, so the specific items often vary from country to country. As the items that consumers regularly purchase change with shifts in the marketplace, governments modify both the specific items in the basket of goods, and the weight that each price carries in calculating the index, to ensure that the CPI continues to accurately reflect the cost of living.
Governments calculate national CPI in relation to a baseline year. This is usually the year in which the government established a basket of goods and began tracking its prices. For every subsequent measurement period, the total of prices in that basket of goods is recalculated and compared to the baseline year to produce a new value. The new CPI is determined by taking the percentage change between the baseline year and the new measurement period, multiplying it by 100, then adding this number to 100. This means that if the price of the basket of goods in a subsequent measurement period was 10% higher than the baseline year, then the CPI for that period would be 110.
Inflation, which is the degradation of a currency's value that results in higher prices, is a concern of every central bank. A certain amount of inflation is healthy in times of economic growth, but too much inflation can hurt an economy when it slips into a recession or depression. Central banks issue what is called an inflation target each year: a percentage by which they expect the overall prices in an economy to increase. The primary purpose of the national CPI is for central banks to measure inflation each year, and see if inflation in their nation's economy met, fell short of, or exceeded the inflation target they respectively issued. Banks do this by calculating the percentage change between the current year's CPI and the year directly preceding it.
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