Why Do Different Consumer Inflation Gauges Show Different Rates?
June 25, 2021
The Commerce Department announced that consumer prices climbed 3.9% in May as compared to a year before. While this is a steep increase, it is not as severe as the 5% increase that the Department of Labor reported two weeks ago.
So why do two official government consumer inflation gauges yield different results? Well, it comes down to how they are constructed and what they track. The Wall Street Journal recently provided a breakdown of how they are calculated.
While both generally move in the same direction, Labor’s consumer price index (CPI) tends to run hotter than Commerce’s index of personal consumption expenditures (PCE).
CPI is meant to be a capture of the cost of living based on what urban consumers pay for a specific basket of goods and services. PCE does the same but is broader because it includes prices in rural areas. It also includes the prices that are paid by nonprofit organizations that provide household services and the prices paid by government programs like Medicare and Medicaid, as well as by employer-sponsored healthcare plans.
Housing and healthcare costs account for most of the difference between the two. Housing accounts for roughly 40% of the CPI calculations, but just 20% of the PCE index. Medical costs constitute around 20% of the PCE index, but less than 10% of the CPI. The PCE index also uses a formula that accounts for what is known as the “substitution effect” that occurs when consumers buy more of one product and less of another as prices change. This means that if apples become more expensive and shoppers buy oranges instead, the PCE accounts for this, while the CPI does not.
CPI tends to get attention in the media because it is released earlier in the month. PCE, however, ultimately matters more for investors and economists, because it is the Federal Reserve’s preferred gauge to assess inflation.