An easy-to-understand explanation of the consumer price index (CPI)

What is CPI

The Consumer Price Index (CPI) is an economic statistic that tracks price changes for goods and services purchased in everyday life. In simple terms, it is an important indicator that shows how much our cost of living is rising (or falling). The CPI measures the price trends of a “shopping basket” that reflects the spending patterns of the average household, covering everything from groceries to housing, healthcare, and entertainment.

This data is utilized by all stakeholders, including policymakers, businesses, and investors, to understand the inflation rate. It is a key indicator that cannot be ignored, especially for investors interested in the cryptocurrency market, as it directly impacts financial markets and investment decisions.

CPI Calculation Mechanism

The process by which government statistical agencies, such as the U.S. Bureau of Labor Statistics (BLS), calculate the CPI consists of the following steps.

Step 1: Composition of Product Basket

Statistical agencies select representative goods and services that general consumers purchase regularly. This includes a wide range of items from necessities such as food, clothing, transportation costs, medical expenses, gasoline, and communication costs to discretionary spending. This basket is designed to reflect the average household expenditure.

Step 2: Collecting price data and tracking by region

The prices of selected items are regularly collected from multiple sales channels, such as retailers, online marketplaces, and service providers. By considering price differences by region and simultaneously recording prices in different areas across the country, a more accurate national average can be calculated.

Step 3: Applying Weights

Weights are assigned to each item in the basket based on their importance in the average household. For example, if housing expenses account for a large proportion of the household budget, a higher weight is assigned to housing-related items. This allows the actual consumption structure to be reflected in the index.

Step 4: Comparison with the reference period and indexing

The index value is calculated by comparing the price data of each period to the base period (usually set at 100). For example, if the CPI is 110, it means there has been a 10% increase in prices from the base period.

The Main Role and Utilization of CPI

Inflation Measurement Tool

The CPI is the most representative inflation indicator that shows the degree of decline in purchasing power over a certain period. It serves as an important reference for policymakers and businesses when forecasting the economy.

Automatic Adjustment Mechanism for Benefits

Government benefits such as social security benefits and pensions are often automatically adjusted in line with the CPI. This ensures that the real value of benefits is preserved over long periods.

Guidelines for Monetary Policy

Central banks monitor CPI data and utilize it for decisions on interest rate policy. During periods of high inflation, they raise interest rates to suppress demand, while during periods of low inflation, they lower interest rates to stimulate the economy.

inflation-linked financial product

Investment products such as Treasury Inflation-Protected Securities (TIPS) are designed to be linked to fluctuations in the CPI, allowing investors to use them to defend their assets against inflation.

The Chain Reaction of CPI's Impact on the Economy

Impact on Consumption Behavior

When prices rise rapidly (CPI increase), consumers' purchasing power decreases, leading to a tendency to curb spending. Conversely, when CPI stabilizes or decreases, consumer behavior becomes more active, and overall demand in the economy increases.

Impact on the interest rate market

Central banks such as the Federal Reserve Board (FRB) pay close attention to CPI trends when making interest rate adjustments. In a high inflation environment, raising interest rates cools the economy, while in a low inflation environment, lowering interest rates aims to stimulate economic growth.

Adjustment of the labor market

Companies may adjust wages in response to CPI increases in order to maintain the real purchasing power of employees. Labor unions also use CPI data as an important negotiation tool during salary negotiations.

Automatic adjustment of government policies

Social welfare policies and tax system figures are regularly reviewed based on the CPI to respond to inflation.

The Relationship Between CPI and the Cryptocurrency Market

Effects on the overall financial market

CPI is directly linked to interest rate decisions, which affects all financial assets, including Bitcoin. The impact on the cryptocurrency market is multi-layered, but there are several key mechanisms at play.

Demand as an inflation hedge asset

In an environment of prolonged inflation, investors seek defensive measures against the depreciation of traditional assets. Due to the characteristic of fixed supply, cryptocurrencies like Bitcoin are increasingly being considered by investors for inclusion in long-term portfolios as an inflation hedge asset. Although price fluctuations are significant, they have come to be recognized as one of the options in an inflationary era.

Interest rate environment and sentiment

When CPI indicates high inflation, central banks tend to raise interest rates. In a rising interest rate environment, low-risk investments become more attractive, leading to outflows of funds from high-risk assets such as cryptocurrencies. On the other hand, in a declining interest rate environment, an increase in money flows into the cryptocurrency market is expected, tending to create upward pressure on prices.

Trust in fiat currency in the long term and the spread of crypto assets

If excessive inflation continues, there is a possibility that trust in traditional fiat currencies will be eroded. Against this backdrop, interest in cryptocurrencies with limited supply may increase, potentially leading to wider adoption and usage.

How to Utilize for Investment Decisions

Understanding the trends of the CPI is essential for anticipating changes in the economic environment and making more informed investment decisions. If the CPI data is in an upward phase, it is necessary to consider the possibility of monetary tightening and interest rate increases by the central bank, and to examine how this may impact various asset classes, including cryptocurrencies.

Conversely, in situations where the CPI decreases or the pace of its increase slows down, it suggests the continuation of accommodative monetary policy, which increases the likelihood of a positive environment for risk assets.

In simpler terms, the CPI is the “thermometer of the economy,” and by reading this signal, one can more accurately grasp the direction of the entire financial market, including the cryptocurrency market. Regularly checking CPI data and understanding its economic implications is the foundation for making informed investment decisions.