Thursday, 18 April 2024

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CPI vs. PCE Confusion Debunked – TipRanks Financial Blog

CPI vs. PCE Confusion Debunked – TipRanks Financial Blog

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Investors are rightfully confused over which inflation report to follow, is it the most often quoted Consumer Price Index (CPI) report or the Federal Reserve’s supposed favorite Personal Consumption Expenditures (PCE) data. One of these inflation measures currently suggests the U.S. is winning its fight against inflation, the other tells a conflicting story. The confusion has investors understandably asking the question, how can the same economy spit out two very different inflationary tales?

First, it’s important to recognize the clear differences in the methodologies used to calculate CPI and PCE, indicating the extent of price increases for Americans. While both indices usually align closely, differing by rarely more than 0.3%, their methodologies can at times yield significantly different results. Investors should also understand the reason behind the Federal Reserve’s preference for one over the other. With this understanding, investing amid this mix of inflation data becomes less of a mystery.

How the CPI and PCE Reports are Different

The Consumer Price Index (CPI) measures prices of the same fixed basket of goods month-to-month and year-to-year and then compiles the difference in the total price of the same basket of items.

Alternatively, Personal Consumption Expenditures (PCE) measure the costs of what was actually purchased within the U.S. month-to-month and year-to-year. Therefore, if consumers decided to buy less of a more expensive luxury item, like substitute cheaper candy for more expensive chocolate, the inflation report would express what was actually experienced by consumers.

Additionally, CPI includes only out-of-pocket expenses for consumers, whereas PCE measures the full cost. This comes into play when medical costs rise rapidly, CPI may measure the same out-of-pocket cost for consumers as in previous periods, while PCE would reflect a big increase as the procedure did cost more, even if insured consumers weren’t billed a higher amount.

Disparity in CPI and PCE Inflation Reports

In the latest readings of the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) inflation measures, a significant disparity became evident, amounting to a full percentage point difference.

Interestingly, the PCE price index from last week demonstrated core annual inflation at 2.8%. Here, ‘core’ signifies the exclusion of volatile food and energy costs from the calculation.

Contrastingly, an…

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