The real measure of Consumer inflation: The PCE Index

What is PCE?

Personal Consumption Expenditures (PCE) is a measure of inflation. PCE is a measure of the total amount of money that households spend on goods and services. It is a critical component of a country's GDP.

The PCE index includes spending on durable goods, which are goods expected to last for at least three years, such as cars and appliances, and nondurable goods, which are goods expected to last for less than three years, such as food and clothing. It also includes spending on services such as healthcare, education, and transportation. PCE is an essential indicator of economic activity, as it reflects households' demand for goods and services.

If that made little sense, imagine you're at the grocery store and want to buy some milk. You see two options: one is $3, and the other is $4. Because your precious dog coins are down 90%, you decide to go for the cheaper option and buy the $3 milk.

Let's say you go back to the store a few months later, even worse off because your dog coins went down another 90%. The same two options are available, but this time, the $3 milk is now $4, and the $4 milk is now $5.

That's where the personal consumption expenditure price index comes in. It measures the price change over time for the goods and services people typically buy, like milk, bread, and gasoline. It helps us understand how much or less we have to pay for the things we need or want to buy.

So, in this example, the personal consumption expenditure price index would show that milk prices have increased by 33% (from $3 to $4) over the past few months.

Understanding the PCE index

The Bureau of Economic Analysis (BEA) of the United States Department of Commerce calculates it. It tracks inflation and deflates nominal values in the national income and product accounts.

The PCE price index is based on households' fixed basket of goods and services. The basket is updated periodically to reflect changes in consumer spending patterns. The weights of the goods and services in the basket are based on their relative importance in household consumption.

To calculate the PCE price index, the BEA collects data on the prices of goods and services in the basket and household quantities consumed. It then calculates the weighted average of the prices using the weights of the goods and services as the weights. The index is set to equal 100 in a base year, and the value of the index in other years is calculated as the percentage change from the base year.

For example, if the PCE price index were 120 in a given year, this would indicate that the overall price level of the goods and services in the basket consumed by households was 20% higher than in the base year.

CPI and PCE Difference

The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index are two measures of inflation commonly used to track changes in the prices of goods and services consumed by households. While they both measure the price changes of goods and services consumed by households, there are some critical differences between the two indices:

1. Basket of goods and services: The CPI and the PCE price index use different baskets of goods and services to measure price changes. The CPI basket is based on a fixed set of goods and services consumed by urban households and is updated every two years. The PCE price index basket is based on a fixed set of goods and services consumed by all households and is updated annually.
2. Weighting: The CPI and the PCE price index use different weighting schemes to measure the relative importance of different goods and services in the basket. The CPI uses a fixed set of weights based on urban consumers' expenditure patterns in the base year. The PCE price index uses a chain-weighting scheme, which means that the weights are updated yearly to reflect changes in the relative importance of different goods and services in household consumption.
3. Coverage: The CPI and the PCE price index measure price changes for different goods and services. The CPI covers a broader range of goods and services, including rents and owner-occupied housing, while the PCE price index excludes these items.

The best metric

The PCE index is the best because FED uses the PCE price index as its preferred measure of inflation for monetary policy. This is because the PCE price index is considered to be a more comprehensive measure of the overall price changes of goods and services consumed by households than the Consumer Price Index CPI.

One of the main reasons why the FED prefers the PCE price index is that it covers a broader range of goods and services than the CPI. The PCE price index includes a more comprehensive range of household goods and services, such as medical care and financial services, which the CPI does not cover. In addition, the PCE price index uses a chain-weighting scheme, which means that the weights of the goods and services in the basket are updated yearly to reflect changes in the relative importance of different goods and services in household consumption. This makes the PCE price index more responsive to changes in consumer spending patterns than the CPI.

In summary, the FED prefers the PCE price index as its measure of inflation because it is a more comprehensive and representative measure of the overall price changes of household goods and services. As investors, we should be looking at this for a potential pivot (a pivot is not coming soon, relax).

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