Bulletin
Investor Alert

London Markets Open in:

Econofact Archives | Email alerts

Aug. 9, 2022, 2:49 p.m. EDT

Are you confused about why there are so many different inflation measures? We can explain.

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    Wheat Continuous Contract (W00)
  • X
    Live Cattle Continuous Contract (LC00)
  • X
    Corn Continuous Contract (C00)

or Cancel Already have a watchlist? Log In

By Daniel Sichel

1 2

The CPI focuses on expenditures by households, and it only tracks prices of items purchased directly by households (so-called out-of-pocket expenditures). Thus, for example, medical care provided by an employer is out of scope for the CPI. In contrast, the PCE price index tracks prices of all items consumed by households because that is the relevant concept for adding up to GDP. Accordingly, the PCE index would include employer-provided medical care. These differences in the aggregation formula and coverage are important reasons for the Federal Reserve’s preference for the PCE index.

Given the differences between the measures, PCE and CPI inflation can differ by notable amounts.  Indeed, the latest read on twelve-month PCE price inflation was  6.8%  for the overall index and 4.8% for the core index, lower rates compared with the 9.1% headline CPI and 5.9% core CPI for the same period. One important reason for this difference is that the expenditure shares of food, energy, and housing are smaller in the PCE index than in the CPI because PCE includes items not in the CPI and that dilutes the share of other items.

The Federal Reserve has a target for inflation of 2% for the overall PCE price index.  On a PCE basis, current inflation readings are well above the Fed’s target (though not as far above as CPI inflation) and, accordingly, the Federal Reserve has been raising interest rates /zigman2/quotes/210002368/delayed FF00 +0.0052% to slow the economy and reduce inflation. The basic mechanism is that higher interest rates /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.87% are intended to tamp down spending.

Effects will be felt especially in sectors for which borrowing often is involved to finance purchases, including housing, other large-consumer purchases such as cars, and business investment. Indeed, the housing sector appears already to be slowing. Reduced spending should, in time, bring overall demand back into balance with the economy’s ability to produce goods and services and that balance should lead to lower inflation.

What this Means:

By any measure, inflation has surged in the past 18 months with rates well above the Federal Reserve’s 2% target. Although the headline CPI has received the lion’s share of media attention, other inflation measures are important and serve different purposes. Key differences include what is covered by the index and how prices of different items are combined to construct an overall index.

Moreover, some measures capture overall changes in the cost of living, while others focus more on the underlying trend in inflation. Another important aspect of official inflation measures is that they are designed to capture inflation for the “average” household, and most households’ inflation experience will differ from that reflected in official measures.

Daniel Sichel is an economics professor at Wellesley College. His research interests include macroeconomics, economic growth, technology, and economic measurement.

More on inflation

Further evidence that Black, Native American and Latino families are feeling inflation’s burn more than white peers

Opinion: Inflation is spiking around the globe, not just in the United States

Top Fed officials back aggressive interest-rate hikes until inflation eases

/zigman2/quotes/210002368/delayed
US : U.S.: CBOT
$ 95.66
+0.0050 +0.0052%
Volume: 963.00
Dec. 9, 2022 12:11a
loading...
/zigman2/quotes/211347051/realtime
add Add to watchlist BX:TMUBMUSD10Y
BX : Tullett Prebon
3.46
-0.03 -0.87%
Volume: 0.00
Dec. 9, 2022 1:24a
loading...

1 2
This Story has 0 Comments
Be the first to comment
More News In
Economy & Politics

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.