The second reason for the divergence is due to the difficulty of reconciling measurement differences in the current inflation environment. Individual item level measurement differences alone accounted for roughly one-fifth of the aggregate price index differences in the second quarter coinberry review of 2022. The items which contributed to this the most were gasoline and air transportation expenditures. Historically, these differences, referred to as ‘price effects’, have been negligible on average, however in the past two years they have become increasingly volatile.
- The increase in the aggregate reflects a large increase in the prices of more-processed food items (up an annualized 5.9 percent) and a slight decline in the prices of less-processed food items (down an annualized 0.9 percent).
- CPI measures only the out-of-pocket healthcare costs of households where PCE includes healthcare purchased on behalf of households by third parties, including employer-provided health insurance.
- Compared with December 2020, the price index for fuel oil was up 41.0 percent, while the price indexes for electricity and natural gas were up 6.3 percent and 24.1 percent, respectively.
- The chart below breaks down the differences between the CPI and PCE into these four effects for each quarter starting in 2007.
The most recent PCE price index data was released on March 29, covering the month of February. The headline February PCE inflation figure was +2.5% year over year, which is slightly more than the annual rate of +2.4% in January. Although this is a slight uptick, generally, PCE inflation has been trending steadily downward since the most recent peak rate of +6.9% in June 2022. The PCE price index looks at U.S. inflation by measuring changes in the cost of living for households.
It tracks the prices of a basket of goods and services, each with different weightings, to reflect how much a typical household spends every month. Prices for goods and services change activtrades review constantly, rising and falling as companies and consumers react to trends in the economy. When you measure these price changes across an entire economy, that’s the rate of inflation.
Core PCE and the Federal Reserve
The Fed depends on the nuances that the PCEPI reveals because even minimal inflation can be considered an indicator of a growing economy. Annual core PCE inflation in February, plus500 review however, dropped slightly from January’s adjusted reading of +2.9% year over year. The Fed uses the core PCE price index as its preferred measure of U.S. inflation.
Prices for Core Goods, Services Rise Sharply
Consumers’ incomes continued to increase in February, while spending rose even more. Taylor Tompkins has worked for more than a decade as a journalist covering business, finance, and the economy. She has logged thousands of hours interviewing experts, analyzing data, and writing articles to help readers understand economic forces. Sign up for our monthly newsletter to get the latest research, expert interviews, and upcoming events from the Cleveland Fed. The PCE price index collects data on some different types of goods and services than the CPI does.
What To Expect From the Fed’s Preferred Measure of Inflation Thursday
The interest rate sensitivity of the housing sector coupled with its prominence in consumer expenditures means that misjudging its relative price movements can potentially lead to policy errors. In the current environment where an expediated rise in housing prices has led to the current divergence between PCE and CPI, it is possible that the reverse trajectory may result in a similar divergence. The Federal Reserve would then have to decide whether they are seeing a clear indication of disinflation in a scenario where one index is declining at a faster rate than the other. If the Fed’s current task were compared to landing a plane on a narrow runway, this would be like adding a thin layer of fog into the equation. This uncertainty will likely complicate the ability of the Fed to definitively say that inflation is coming down but should not be insurmountable.
The first is that PCE underweights shelter costs relative to CPI due to its inclusion of third-party expenditures. During periods in which housing prices and rents rise rapidly, such as they have recently, CPI will rise by more than PCE. In the lead-up to 2008, we saw a similar result with CPI outpacing PCE, although the volatility of fuel prices at the time somewhat obscured the effect on the aggregate indexes. In the current environment, fuel prices have been rising in concert with shelter costs, which has been a major factor in the record level of divergence between CPI and PCE. The Fed’s reasoning for using the PCE index over CPI is valid and the current divergence is unlikely to motivate them to change preferred measures. However, it would be imprudent for the FOMC to ignore the underlying factors which can cause these two indexes to deviate by such large margins.
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