The index, which measures inflation in consumer expenditure and excludes volatile food and energy expenses, climbed 5.4 percent between February 2021 and February 2022. Since April 1983, this was the fastest growth.
The Federal Reserve’s favored measure of inflation is the PCE index, and last month’s figure was much below the central bank’s target of approximately 2%. The Federal Reserve hiked interest rates for the first time since 2018 earlier this month in a bid to cool surging prices.
Higher costs were sparked earlier in the pandemic by strong demand and supply chain issues. However, the global commodities markets have been thrown for a loop since Russia invaded Ukraine last month. According to the BEA, energy costs increased by about 26% in February. Despite a recent pullback, US oil prices rose about 9% last month and have soared even higher in March. The effect is being felt at the gas pump in the United States.
“Prior to the return of inflation, the Fed would have been less hesitant to raise rates in the face of war or other threats to economic growth, but in this situation, with inflation likely to be exacerbated by war-related disruptions, the Fed must do the opposite of what they would normally do, which is to fight an even bigger threat of inflation, according to Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, in an emailed statement.
In terms of inflation numbers, the economic fallout from the Ukraine crisis will last longer than February. As the violence continues to damage the global agricultural supply chain, food prices, for example, jumped 8% in February and are anticipated to rise throughout the year.
Economists expect inflation to peak in the first quarter and then gradually decline for the rest of the year. It’s unclear whether February was the peak.
“In a letter to clients, Action Economics chief economist Mike Englund said, “The peak in year-over-year inflation measures has remained elusive, but we anticipate that a top is emerging in March if the pull-back in energy prices is sustained.”
Despite the fact that inflation is out of control, Americans continue to spend at least for the time being. According to data released on Thursday, consumer expenditure grew 0.2 percent, or $34.9 billion, last month.
Consumers are purchasing because of their higher salaries and savings. Incomes in the United States increased by 0.5 percent, or $101.5 billion, in February, while disposable income increased by 0.4 percent, or $76.1 billion. The personal savings rate was 6.3 percent at the end of the year, up from 6.2 percent at the start of the year.
However, analysts are concerned that costs may rise to the point where consumers may radically alter their spending habits, deferring purchases or switching to cheaper alternatives. That would be bad news for the US economy, which relies on consumer spending for two-thirds of its growth.
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Is CPI or PCE used by the Fed?
Another indicator of inflation is the price index for Personal Consumption Expenditures (PCE price index), which is calculated by the Bureau of Economic Analysis (BEA) using data from the Bureau of Labor Statistics (BLS). The PCE price index tracks price changes across the board, not simply those paid for out of pocket by consumers. The weight on health care in the PCE, for example, includes what customers pay out-of-pocket for premiums, deductibles, and copayments, as well as costs covered by employer-provided insurance, Medicare, and Medicaid. Only the direct expenses to consumers are represented in the CPI. Because of this difference in scope, the PCE deflator and the CPI have drastically different weights. The weight on health care, for example, is 22 percent in the PCE index but only 9 percent in the CPI. Housing has a 42 percent weight in the CPI but only 23 percent in the PCE index. That indicates that a given increase in health-care prices will have a significantly greater impact on the PCE index than on the CPI.
The PCE price index is the Fed’s primary inflation gauge. Its long-term inflation aim is for the PCE price index to rise at a rate of 2% annually over time.
The PCE is a chained index as well, although the CPI is not. As with the chained CPI, the PCE is better at accounting for substitutions between similar items as one gets more costly. The PCE is said to be a more accurate picture of pricing changes over time and across items because its calculation incorporates updated data. The two metrics tend to follow a similar pattern over time, however the PCE increases by 2 to 3 tenths less than the CPI. For example, from 2010 to 2020, the CPI-U climbed 1.7 percent per year on average, while the PCE price index increased 1.5 percent per year on average.
Why does the Federal Reserve use PCE instead of CPI?
The Federal Reserve said in January 2012 that the PCE would be its primary measure of inflation at its monthly Federal Open Market Committee meeting, preferring it for three reasons:
- As people substitute away from some goods and services and toward others, the expenditure weights in the PCE can shift. As a result, if the price of bread rises, consumers buy less bread, and the PCE adjusts its basket of items to account for this. The CPI, on the other hand, is less responsive to shifting consumer choices.
- PCE data is more flexible than CPI data, which can only be modified for seasonal factors and for the preceding five years.
In short, the CPI reflects a basket of products and services that a customer would purchase if prices were to fluctuate without making substitutions. The PCE includes a greater range of goods and services from a broader group of buyers than the CPI. It attempts to track what is really purchased and depicts how consumers’ purchasing patterns change when relative prices change. As a result, price movements in the PCE are smoother, and reported inflation is often smaller, at least as perceived by consumers.
Forecasting future inflation is difficult even in calm times, but it’s even more difficult as the US economy recovers from pandemic lockdowns (with highly contagious variations potentially confounding the re-opening picture). The labor market is a major factor influencing inflation, and it’s worth keeping an eye on the underlying developments. Wage pressures have been subdued so far, but any future pay increases are likely to be reflected in goods and services over time, and so show up in both CPI and PCE. Please visit my colleague Jim Van Heuit’s blog piece for more information on the labor market and inflation.
What is the most accurate inflation indicator?
To measure different aspects of inflation, various indices have been established. Inflation is described as a process in which prices continue to rise or, in other words, the value of money continues to fall. The Consumer Price Index (CPI) measures inflation as it affects consumers’ day-to-day living expenses; the Producer Price Index (PPI) measures inflation at earlier stages of the manufacturing process; the International Price Program (IPP) measures inflation for imports and exports; the Employment Cost Index (ECI) measures inflation in the labor market; and the Gross Domestic Product (GDP) Deflator measures inflation as it affects both consumers and governments. Specialized measures, such as interest rate measures, are also available.
The “best” inflation measure is determined by the data’s intended use. When the goal is to allow customers to acquire a market basket of goods and services equal to one they might purchase in a previous period at today’s prices, the CPI is often the appropriate metric to use.
What method does the US government use to calculate inflation?
The Consumer Price Index (CPI) is used by the United States Bureau of Labor Statistics (BLS) to calculate inflation. The data for the index comes from a survey of 23,000 firms. 10 Every month, it records the prices of 80,000 consumer items.
Why does the Fed employ PCE?
The Fed’s Preferred Inflation Measure The PCE was preferred by the Fed for three main reasons: The PCE formula adjusts to changing customer preferences more quickly. It gives a more detailed breakdown of expenses. Data from the past can be updated to reflect current information.
What’s the difference between CPI and PCE?
The CPI covers changes in all urban households’ out-of-pocket spending, while the PCE index measures changes in goods and services used by all households and nonprofit institutions that serve households.
What is the PCE used for?
A measure of the prices that people in the United States pay for products and services, or those who buy on their behalf. The PCE price index is well-known for tracking changes in consumer behavior and capturing inflation (or deflation) across a wide variety of consumer spending.
Why does the Federal Reserve use core PCE inflation as a measure of inflation?
The Federal Open Market Committee (FOMC) believes that a 2% annual increase in inflation in the Department of Commerce’s price index for personal consumption expenditures (PCE) is most compatible with the Federal Reserve’s mandate for maximum employment and price stability over the long term. The PCE price index is used by the FOMC because it represents a wide range of household spending. The Fed, on the other hand, keeps a careful eye on other inflation indicators, such as the Department of Labor’s consumer and producer price indexes.
When assessing the pace of inflation, policymakers at the Federal Reserve take the following steps:
- First, because inflation figures fluctuate wildly from month to month, policymakers usually look at average inflation over longer periods of time, such as a few months to a year or longer.
- Second, policymakers analyze the subcategories that make up a wide price index on a regular basis to see if an increase in inflation may be attributable to price changes that are likely to be transient or one-time phenomena. Because the Fed’s policy has a lag, it must make decisions based on its best inflation projection. As a result, the Fed must try to figure out whether an inflation trend is likely to continue or not.
- Finally, to detect inflation patterns, policymakers look at a range of “core” inflation indices. The most prevalent type of core inflation measurements removes commodities that fluctuate in price rapidly or frequently, such as food and energy. For such items, a significant price change in one period does not always imply a subsequent significant price shift in the same direction. Despite the fact that food and energy account for a significant portion of most households’ budgets, and policymakers’ ultimate goal is to stabilize overall consumer prices, core inflation measures that exclude volatile prices can be useful in monitoring inflation trends.
Related Information
“Median CPI & Inflation Measurement,” Federal Reserve Bank of Cleveland. (See the trimmed-mean Consumer Price Index for more information.)
“National Economic Accounts,” Bureau of Economic Analysis, United States Department of Commerce. (Under the categories Gross Domestic Product (GDP) and Personal Income and Outlays, you can find information on price indexes for personal consumption expenditures.)
Is inflation being calculated correctly?
Inflation is defined by the Bureau of Labor Statistics as “a process of continually rising prices or, equivalently, a continuously diminishing worth of money.”
As I previously stated, the CPI is not a measure of growing prices; rather, it measures changes in consumer spending patterns as prices change. The CPI ignores the diminishing value of money entirely. If it did, the CPI would be significantly different.