What Actually Makes Up the CPI—and What Inflation Measures Really Mean

Anthony Sandomierski |

What Actually Makes Up the CPI—and What Inflation Measures Really Mean

Inflation is one of those words we hear constantly in the news, yet few people truly understand how it’s measured. When you hear that “inflation is 3.2%,” that number usually comes from the Consumer Price Index (CPI). But the CPI is just one tool in the toolbox, and the Federal Reserve often looks at other measures when deciding on interest rates. Let’s break it down.

What the CPI Really Measures

The Consumer Price Index (CPI) is designed to measure changes in the cost of living for urban households. It tracks a “basket of goods and services” across categories like:

  • Housing (rent, owners’ equivalent rent, utilities) – the single largest portion, nearly one-third of CPI
  • Food and beverages – groceries, dining out, alcohol
  • Transportation – vehicle prices, gas, public transit
  • Medical care – health insurance, hospital services, prescription drugs
  • Apparel – clothing and footwear
  • Recreation & education – childcare, tuition, entertainment, electronics

The Bureau of Labor Statistics collects prices every month and weights them based on typical household spending patterns. When gas prices spike, for example, the transportation component rises and pulls the overall CPI higher.

Headline vs. Core CPI

You’ll often hear about two versions of CPI:

  • Headline CPI: Includes all items—this is the number reported in the headlines.
  • Core CPI: Excludes food and energy, which are considered too volatile to show the underlying trend.

Core CPI tends to matter more to policymakers because it strips out the “noise” of things like weather-driven energy costs or seasonal food swings.

Other Measures of Inflation

While CPI is the most publicized, it isn’t the only measure.

  • Producer Price Index (PPI): Tracks what businesses pay for raw materials and wholesale goods. Think of it as “inflation upstream.”
  • Personal Consumption Expenditures (PCE) Index: Captures household spending more broadly and adjusts for changes in consumer behavior (like switching from steak to chicken if beef prices rise).
  • Trimmed Mean & Median Inflation: Specialized measures that remove extreme price changes to find the “middle ground” of inflation trends.

What the Federal Reserve Watches Closely

Here’s the key: the Federal Reserve doesn’t use CPI as its primary gauge of inflation. Instead, it focuses on the Personal Consumption Expenditures (PCE) Price Index—especially Core PCE.

Why?

  • Broader coverage: PCE includes more goods and services than CPI.
  • Behavioral adjustments: PCE accounts for how consumers change spending habits when prices rise.
  • Consistency: It aligns better with the Fed’s economic models.

The Fed’s stated inflation target—2%—is specifically tied to Core PCE, not CPI. That’s why you might see CPI inflation at 3% while the Fed is saying inflation is closer to 2.6%.

Why This Matters to You

Understanding which inflation measure policymakers rely on helps you interpret headlines more accurately. If you only look at CPI, you may get a distorted picture of what the Fed is thinking. Since the Fed’s decisions on interest rates directly affect borrowing costs, mortgage rates, and investment returns, knowing how inflation is actually measured gives you an edge in planning.