What's in the Basket? An Overview of CPI

It seems like we can't turn on the news or scroll the headlines these days without hearing about inflation — which is fair, since it impacts our daily lives in many ways. But what exactly goes into determining the monthly inflation numbers that get so much attention?

In Canada, those numbers are derived from a precise and dynamic metric — the Consumer Price Index (CPI), which is widely used by economists to measure whether prices for the average consumer are going up or down, and therefore seen as a useful tool in calculating inflation.

More specifically, the CPI measures the average of the price changes of a “basket of goods and services," and is typically referenced in a year-over-year comparison. For example, if the CPI in Canada were 8.1 per cent in a month, that would indicate that over the past year, goods and services had risen in price by an average of 8.1 per cent.

The CPI is frequently shared and cited in economic research and decision-making, and its calculations have a wide impact — federal and provincial governments often use the CPI data to calculate taxation and pension programs. You may hear about "headline" and "core" inflation CPI, especially in the news. Headline inflation CPI refers to raw inflation data. Closely monitored by central banks, including Canada's, core inflation CPI excludes volatile components like food and energy to help measure longer-term trends in inflation.

So how are the weightings and pricings of the CPI basket calculated? The most recent update to the CPI, which was reflected in the May 2022 CPI numbers for the first time, was developed with data collected by the government through household expenditure surveys, in addition to data provided by a number of industry-specific sources, like the Canadian Real Estate Association, urban transit surveys, and air transportation passenger and revenue data. Yet just like the basket itself, these data sources are always being adjusted.

Indeed, in order for the CPI to be an accurate reflection of how inflation is impacting Canadian spending, the "basket" must be frequently updated to match changes in consumer habits. Given that the CPI includes over 700 goods and services, this means those categories, and their assigned weights (what percentage of household spending goes toward said product) must be refreshed on an annual basis to keep up with changes in consumption.

For example, between 2019 and 2020, the CPI basket had to be adjusted to make up for the fact that most consumers did not have the option of spending money on in-person entertainment, travel or dining. Therefore, essentials related to food, shelter and health were weighed at a higher value. It then had to be updated the next year to reflect the easing of pandemic restrictions in 2021. One such adjustment coming out of the pandemic was in the weighting of "alcoholic beverages served in licensed establishments," which rose 0.12 percentage points to 0.69 per cent of the basket share for this year's CPI, reflecting the easing of in-person dining restrictions.

Pandemic aside, technology trends and lifestyle habits are always evolving, and have a lot to do with basket adjustments. Think, for instance, of how much the average Canadian household spends on cellphone bills. It's likely quite a bit more than 25 years ago, but on the other hand, the household is probably spending a lot less on goods or services that have been eclipsed by technology, such as CDs or video rental fees. Therefore, the basket weighting for cellphone expenditures has risen, while the category related to video rentals has been eliminated.

Costs like rent, tenants insurance, mortgage costs and property taxes are also on the rise, and included in the picture. Home buying-related expenses, like realtor and broker fees, have been driving around a fifth of Canadian inflation to date and are captured in the "other owned accommodation" category of the basket.

Another reason the CPI basket must be updated relates to the way consumers adjust their spending in certain economic conditions. During a recession, for example, families might reduce their restaurant consumption and buy more food from the grocery store, or cut back on meat, opting for meals that are cheaper to prepare.

Though the CPI has come to be seen as a flexible model that well-encapsulates the impact of inflation on household spending, the CPI only reflects the pricing of a specific basket to illustrate inflation or deflation — it cannot measure how much total spending is changing. Other metrics do this, including the RBC Spending Tracker, which reinforces the CPI's findings while adding information about credit use or gross spending.

Combined with other metrics like the spending tracker, inflation watchers and policy makers are able to get a more accurate, up-to-date reflection of consumer behaviour. By frequently updating the basket to reflect the changing consumption habits, the indicator continues to be a key reflection of the true impact of inflation on Canadian households.