How to Use the Consumer Price Index

The Consumer Price Index (CPI) is a tool used to measure inflation. It is calculated by tracking the cost of a basket of goods over time. The goods in the basket reflect the typical expenditures of consumers. Employers commonly use the CPI to adjust wages for inflation, but there are other uses like adjusting rents or child support. Read on to learn how to use the Consumer Price Index.

Instructions

Difficulty: Moderate

1. Set the baseline clearly. Outline the parts of a compensation package you will adjust for inflation. For example, tie salary or hourly wages to inflation, but make the annual bonus have no link to inflation.
2. Choose which CPI to use. One primary distinction is the CPI-U and CPI-W. The CPI-U includes all urban consumers, 87 percent of the U.S. population, while the CPI-W covers households that derive most of their income blue collar work, or 32 percent of the population. There are indexes specific to regions or cities and those that measure changes of goods in certain categories, such as rent.
3. Agree on a reference period. You must decide whether you will adjust according to a yearly average, a particular month or some other time period. The main urban indexes are published every month, but some of the other indexes that are published bimonthly or twice a year. Take this into consideration when choosing an index and reference period.
4. Specify how often you will make adjustments. Typically wage adjustments are made on an annual basis.
5. Establish a formula for adjustments. To use one common method, divide the new CPI by the old CPI and multiply the old price or wage by the result. For example, 105 divided by 100 is 1.05, multiply that by your wage $10.00 per hour and you have your new wage, $10.50.
6. Decide if you want to include a cap or floor to reduce the effect of inflation. For example, a floor at one percent guarantees a small increase each year even if inflation is negligible.

Tips & Warnings

• The Bureau of Labor Statistics revises the Consumer Price Index occasionally. Make provisions for these changes in your contracts and agreements.

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