The Politics of Price Measurement: CPI Is the Sole Measure of Retail Inflation, But the Fed Prefers PCE
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In February, total consumer prices and prices, excluding food and energy, rose 0.4%, resulting in the last twelve-month increases of 3.2% and 3.8%, respectively. The consumer price report is the sole direct measure of retail inflation, capturing what people buy for consumption.
However, the Fed favors the PCE deflator, which is not a direct measure but rather a blend of CPI prices with administered prices (Medicare and Medicaid). This preference is based on the belief that the PCE captures what people purchase in real time, reflecting the substitution effect of price change.
But this claim is misleading. Detailed spending data, crucial for accurate measurement, is unavailable in real-time. The choice of the PCE over the CPI for inflation measurement is driven by political considerations, as it tends to produce a lower rate.
The Bureau of Economic Analysis (BEA), the government agency responsible for estimating and publishing the PCE deflator, faces significant challenges in data collection for various product categories. For instance, while BEA has a small set of product details updated monthly, such as motor vehicles, prescription drugs, gasoline, and tobacco, other categories suffer from a considerable lag.
For instance, food store sales are supplemented with annual scanner data, resulting in a one-year lag. Similarly, the yearly e-commerce survey report provides additional product details with a one-year lag.
Detailed consumer expenditures for services are also unavailable when the PCE deflator for a given month is estimated and released. The Census's Quarterly Survey of Services (QSS) is released three months after a quarter ends. However, the QSS provides aggregate spending figures for various service industries and offers few details of how much of it is household spending.
Without detailed data, the BEA is forced to rely on imperfect product-to-industry ratios, often based on data from the several-year-old 2017 Economic Census, to estimate household product and service spending. This reliance on outdated data is a significant drawback, as it uses spending patterns from years past to explain how current price inflation impacts people's spending decisions. This practice undermines the accuracy and relevance of the PCE deflator, raising concerns about its effectiveness as a current measure of inflation.
The CPI has been criticized for what it is and isn't (See a recent article by Larry Summers on CPI missing financing costs for consumption). The same should apply to the PCE deflator. The PCE is not what people think it is. Choosing the PCE over the CPI is a convenient way for policymakers to argue that they are close to or hitting their target, even when the only direct measure of consumer price inflation (CPI) runs much higher.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.