What’s the Difference Between the CPI and PCE Indexes?
Shelter Price Weights Cause PCE and CPI to Diverge
Differences between how components are weighted in the two indexes are often responsible for the differences between CPI and PCE inflation readings. That’s especially been the case in recent months. The most pertinent example is shelter prices, weighted roughly double in the CPI Index compared with the PCE Index.
Other Factors Driving Differences In CPI and PCE
Analysts point to other elements responsible for the differences in the two indexes.
The indexes are calculated using different mathematical processes. For example, the PCE formula adjusts its weights monthly, while the CPI does so yearly. When grocery shoppers switch to chicken after beef becomes more expensive, that change shows up in the PCE Index first.
There are also differences in the scope of each index. The PCE report includes purchases made by urban and rural consumers, while the CPI report only tracks spending in urban areas. The CPI includes only out-of-pocket spending made directly by consumers, while the PCE accounts for expenditures made on consumers’ behalf. As a result, health insurance expenses made on behalf of employees by their employers or by Medicare and Medicaid are included in the PCE basket but not the CPI. PCE data also includes spending by nonprofit organizations on households’ behalf.
Other factors include the differences in seasonal adjustment methodologies and the price data used to calculate spending in similar categories. The insurance price calculations in the CPI index tend to produce more volatile price swings than the PCE index.
Why Does the Fed Prefer the PCE Over the CPI?
The Fed has used PCE inflation as its main measure of price pressures in the US economy since 2000. Former St. Louis Fed President James Bullard has named several reasons for this.
First, PCE data is more comprehensive than CPI data. It includes a broader subset of goods and services prices, as well as spending from both rural and urban consumers.
Second, the weights in the PCE are updated more frequently and can better account for consumer substitution. “The PCE can quickly reflect the impact of new technology or an abrupt change in consumer spending patterns,” Bullard wrote in 2022, citing how consumption shifted rapidly from services to goods at the onset of the covid-19 pandemic.
Lastly, the government can retroactively revise PCE data to account for new data or measurement techniques. CPI data is generally only revised to account for seasonal factors.