The Consumer Price Index (CPI) is an important measure to the Canadian economy. Whether it’s a price increase at your local grocery store, a rise in salary or a pension cost of living adjustment, the CPI affects millions of Canadians every day.
Most people use the terms CPI and inflation interchangeably – although both measure price changes over time, they are both different metrics. Let’s define the CPI, look at the difference between the CPI and inflation, and how it affects average Canadians.
Definition of the CPI
The Bank of Canada defines the CPI as “a measure that tracks movements over time in the level of consumer prices.” Simply put, the CPI measures the cost of living for the average Canadian. Statistics Canada tracks on a monthly-basis retail prices of around 600 goods and services an average Canadian family purchases. The goods and services measured include necessities like food, housing, transportation, furniture, clothing, and recreation.
Each month like clockwork Statistics Canada releases its Consumer Price Index Report. The report reads something like this “Consumer prices rose 1.2% in the 12 months to October, matching the increases in August and September.” Similar to housing statistics, the CPI is seasonally-adjusted. The CPI is reported on a nationally, provincially and municipal level.
You probably spend a lot more on food and shelter than haircuts and DVDs (hopefully!). To account for this, each item is given a different weighting base on the portion of disposal income it uses. Items like food and shelter have a higher weight – a price increase from these items will have a bigger impact on a family’s budget.
Calculating the CPI
Although the media typically only mentions increases in the CPI, it’s important to understand how the CPI is calculated. Current month prices are compared to a base year (currently 2002). The basket of goods and services for the base year is assigned a value of 100. Current prices are compared to the base year. For example in 2011 the average CPI was 119.9, meaning you’d have to pay $119.90 in 2011 for the same basket of goods and services that would have cost only $100 in 2002.
The Core CPI is a key measure used by the Bank of Canada to set monetary policy. Although the Core CPI is measured in the same way as the CPI, it excludes eight of the most price-sensitive items – fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products. This enables the Bank of Canada to obtain a clearer picture of the underlying trend of inflation.
The Bank of Canada has adopted and has maintained an inflation-control target in recent years. The target aims to keep the CPI at 2 per cent, in a band of 1 to 3 per cent. The Bank of Canada may consider raising its policy interest rate if the CPI goes above or below this target.
CPI vs. Inflation
Although similar, these two terms are not to be confused. While CPI and inflation both measure the rise over time in the cost of living and can reduce purchasing power, inflation is a broader measure since it includes all goods and services and doesn’t assign individual weightings to goods and services like the CPI.
Economists believe there are two main causes of inflation: demand-pull and cost-push. Demand-pull inflation is the classic example of demand and supply – if demand exceeds supply prices will increase. Cost-push inflation involves companies passing on cost increases (wage increases, higher taxation, increased input costs, etc.) to consumers in the form of price increases.
How does the CPI Affect Me?
Now it’s time to answer the million dollar question (pun intended). Besides price increases at your local grocer, the CPI is felt in many ways. Government benefits such CPP, GIS and OAS increase based on the CPI. CPP benefits are revised annually while the OAS is revised quarterly based on the current CPI. Although the CPI doesn’t include investments like stocks and bonds, the CPI can have an adverse impact on investment returns. You’ll have to achieve a long-term rate of return greater than the CPI to maintain your purchasing power. The CPI is used by employers to determine annual salaries increases for employees.
Many public sector pensions and a decreasing number of private sector pensions include inflation protection. Often referred to as a Cost of Living Adjustment (COLA), pension increases are typically based on the CPI. It’s a good idea to read the fine print in your pension plan booklet, as not all COLAs are equal. It’s important to know how often the COLAs take place (quarterly, yearly or ad-hoc), as well as what percentage of the CPI your pension will be increased by. For example, you may only receive 0.75% of the CPI increase – if the CPI increases 2% you’ll only receive a 1.5% pension increase. Also, some pensions only provide COLAs if the CPI increases above a set per cent, like 2%.
Do you monitor the CPI? How does the CPI affect your lifestyle?
About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University. You can read some of his other articles here.
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