COST OF LIVING INDEX

The Cost of Living Index is a term used to describe a method by which the government measures the rise and fall of prices in the economy. Such measures are important because much government policy, such as the amount paid to senior citizens in Social Security checks, is adjusted according to changes in the cost of living. The Consumer Price Index (CPI), known informally as the cost of living index, is the best known of the government's measures of price changes. The CPI is calculated by tracking changes in the price of a set of consumer items (such as gasoline, housing, dairy products, clothing, etc). The average price increase or decrease for this list is expressed in terms of a percentage change; for example, "the cost-of-living index rose two percent last year" means that consumer prices, on average, rose by two percent. The index is designed to reflect, as realistically as possible, the actual price changes that households face in daily life.

Since a process of steadily rising prices is known as inflation, the rate of change in the CPI is often called the inflation rate. The CPI is one of the most closely watched of all economic indicators. The CPI is the basis for calculating changes in many types of benefit payments, such as pensions. In addition, the government uses the CPI to help set economic policy. A sharply rising CPI may lead the government to restrain economic growth, either by raising taxes or raising interest rates. A very low CPI, in turn, means that inflation remains in check, and the government may decide to stimulate economic activity by cutting taxes or lowering interest rates.

Economists debate how accurately the CPI measures price changes. Some economists contend that the CPI may be somewhat inaccurate because, they argue, it may put too much emphasis on some consumer items, such as milk or gasoline, or not enough on others, such as computers or movie tickets. It is also important to note that the CPI probably will not reflect the experience of any one family. A family that is very careful about how it shops may have a lower cost-ofliving index than a family that pays little heed to price changes.

The government agency that calculates the CPI is the Bureau of Labor Statistics. The CPI is issued monthly.

See also: Consumer Price Index, Inflation, Price