Misconceptions About the Consumer Price Index

By Marc Bazinet

The Consumer Price Index (CPI), produced and published by Statistics Canada, is the most widely used measure of inflation and one of the most closely watched national economic indicators. It may also be one of the most misunderstood.

The purpose of the CPI is to measure the price change of a basket of consumer goods and services. When prices rise, the purchasing power of the dollar declines. The CPI is often used to adjust for this phenomenon by indexing the value of wages, salaries and pensions, as well as tax brackets. Some cities even use the CPI to regulate how much rents can increase. Old Age Security, Canada Pension Plan payments, and other social and income assistance payments are also adjusted to account for changes in the CPI. For these and other reasons, the CPI is relevant to everyone who earns and spends money.

This article addresses four common misconceptions about the CPI.

Misconception #1: CPI inflation does not reflect the reality of individual households

The CPI is calculated by collecting over 60,000 prices each month for nearly 700 categories of goods and services, which, collectively, make up the consumer basket at any one time. This basket represents a composite of all households, ranging from singles and young families to empty-nesters.

Consumers tend to attach greater importance to changes in the prices of the goods and services they buy most frequently, and less to the price changes of occasional purchases. For example, a consumer is likely to notice the price of a litre of gasoline on a daily basis, but might go for years without knowing the price of a new mattress—even though new mattresses are being purchased every day.

The CPI measures price changes in all goods and services throughout the year — even if some households may not be making certain purchases — by weighting a product’s relative importance using its share of total consumer expenditures. Price changes of items such as gasoline and milk are included in the CPI, as are price changes of items that are usually purchased less frequently, such as furniture, home electronics and clothing.

Some consumers believe, based on their personal experiences, that the CPI understates the true rate of inflation, and is not representative of the reality of individual households. Since the CPI aims to track the price change experienced by all consumers in Canada, it may not reflect price changes that affect a particular individual or household at a particular time. Many factors, such as personal preferences and tastes, household composition, lifestyle and mobility, influence what goods and services individuals purchase. The location of purchases, as well as the amount of each product consumed and service purchased also vary from person to person; for example, fuel oil, used for home heating, accounts for a much greater proportion of overall expenditures in the Atlantic Provinces compared with other provinces, where natural gas is used more heavily.

The CPI basket weighting scheme is updated every two years, ensuring that the index continues to be representative as Canadian spending habits change. Big changes to content and classification structure may also be introduced at the time of a basket update.  New items are added and old ones are dropped depending on their relative importance of consumer spending.

Misconception #2: The CPI excludes items, such as gasoline and tobacco

The product scope of the All-items CPI includes nearly all goods and services purchased by households in Canada, for which a market price can be observed, including gasoline and tobacco. No attempt is made to differentiate between “luxuries” and “necessities,” and nothing is omitted on the basis of moral or social judgement.

Although some people may regard the use of tobacco and alcohol, for example, as socially undesirable, these products are included in the CPI basket because they make up a notable proportion of the expenditures of Canadian families and individuals. There are some exceptions that pose practical or conceptual difficulties when producing the CPI; for example, illegal products such as non prescription narcotic drugs, as well as a few legal products, such as gambling services.

In addition to producing the All-items CPI, Statistics Canada produces a number of special aggregate price indexes that exclude certain products that are measured as part of the All-items CPI, because doing so sometimes makes interesting trends more visible. For example, the Bank of Canada’s core index removes the effects of eight volatile basket components from the CPI calculation. These components comprise fruit, fruit preparations and nuts; vegetables and vegetable preparations; gasoline; fuel oil and other fuels; natural gas; mortgage interest costs; inter-city transportation; and tobacco products and smokers’ supplies. The core index also removes the effects of changes in indirect taxes on the remaining components.

The core index is often described as measuring “underlying” inflation, and helps guide the Bank of Canada’s monetary policy. However, the so-called “target” of the Bank of Canada’s monetary policy is the All-items CPI.

Misconception #3:  The CPI does not account for differences between items that are no longer sold and their replacements

The universe of products bought and sold in the marketplace changes over time. When a shop stops selling a product that is included in the CPI sample, the CPI price collector must find a substitute item.

The goal of the substitution process is to find the item that is most similar to the item the CPI had been following. Whenever there is a substitution, a CPI analyst determines whether the new item differs significantly from the item it is replacing.

If the items are comparable, there is no break in the series. If the substitute is notably different from the original product, quality adjustments are performed to account for these differences and ensure that the CPI measures pure price change, and not price change due to quality change.

Misconception #4: The CPI is the only measure of inflation

The CPI is often thought to be the only measure of the rate of price change. This is a common misconception. The CPI is, in fact, one of several indicators of price inflation. The CPI is the most widely used indicator because it is published quickly, is available monthly, is not revised, and measures changes in the prices of consumer expenditure (the single largest component of final demand).

There is no single best measure of price inflation. The preferred measure of inflation depends on the intended use of the data. Statistics Canada publishes measures of price change for different target groups and for different products, using different methodologies. Take, for example, the evolution of gasoline prices: depending on the circumstances, it might be more useful to examine the price of gasoline at the pump (from the Consumer Price Index), the price of gasoline as it leaves the refinery (from the Industrial Product Price Index), or world crude oil prices (from the Raw Materials Price Index).

For more information about the Consumer Price Index, see Your Guide to the Consumer Price Index and The Canadian Consumer Price Index Reference Paper. Additional information on the CPI is also available on Statistics Canada’s website at www.statcan.gc.ca.

Marc Bazinet, Communications Division, Statistics Canada