I get asked frequently about Core PCE inflation. Because the Fed obsesses over Core PCE, as opposed to one of the many flavors of CPI (core, median, trimmed-mean, sticky-price), investors therefore obsess over it as well.
My usual response is that I don’t pay much attention to Core PCE, for several reasons. First, there are no market instruments that are remotely tied to PCE, so you can’t trade it (and, for the conspiracy-minded among you, that means there is no instrument whose market price can call shenanigans if the government figure is ‘massaged’). Second, while PCE is interesting and useful for some uses – it measures prices from a different perspective, mainly from the supplier-side of the equation so that, for example, it captures what Medicare pays for care as opposed to just what consumers pay – those aren’t my uses. Markets respond to inflation, and to perceptions of inflation, but what the government pays for healthcare isn’t something we perceive directly.
So, I care about PCE more than, say, PPI, but only just. The only reason I care about PCE is that the Fed cares about it.
Now, PCE differs from CPI in a couple of key ways – apart from the philosophical way mentioned above, that one measures the price of things businesses sell and one measures the price of things people buy. But those key ways are mostly interesting to pointy-head economists who are interested in calculating the third decimal point. Me, I’m just trying to get “higher” or “lower” correct. (Ironically, those folks who are interested in the third decimal point are the same folks who miss the big figure in front). So they wail at the following chart (source: Bloomberg), and moan about how the Fed has been unable to get inflation higher because of this persistent shortfall of PCE compared to CPI. Try harder!
The pocket-protector set can keep their ‘formula differences.’ There’s really only one important difference that has caused the gap between PCE and CPI over the last half-dozen years: the difference in the weight allocated to housing. In the PCE, “Rental of tenant-occupied nonfarm housing” and “Imputed rental of owner-occupied nonfarm housing” add up to about 16% of the overall PCE. In the CPI, “Rent of primary residence” and “Owners’ equivalent rent of residences,” the corresponding categories, sum to about 32% of overall CPI.