Note from dshort: I've updated the accompanying charts with the latest Personal Consumption Expenditures price index from the Bureau of Economic Analysis. The annualized rate of change is calculated to two decimal places for more precision in the side-by-side comparison with the Consumer Price Index.
The BEA's Personal Consumption Expenditures Chain-type Price Index for July, released yesterday, shows core inflation below the Federal Reserve's 2% target at 1.65%. In contrast, the Core Consumer Price Index, also data through July, is above the target at 2.10%. The Fed, of course, is on record as using Core PCE as its inflation gauge:
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances. [Source]
The October 2010 core CPI of 0.61% was the lowest ever recorded, and two months later, the core PCE of 1.08% was an all-time low. However, we have seen a significant divergence between the headline and core numbers for both indicators, especially the CPI, at least until a few months ago, when energy prices began moderating. The latest headline CPI and PCE are both well off their respective interim highs set in September.
This close-up comparison gives us a clue as to why the Federal Reserve prefers Core PCE over Core CPI as an indicator of its success in managing inflation: Core PCE is lower than Core CPI and less volatile. Given the Fed's twin mandates of price stability and maximizing employment, it's not surprising that the less volatile Core PCE is their metric of choice.
The Bureau of Labor Statistics' Consumer Price Index and The Bureau of Economic Analysis's monthly Personal Income and Outlays report are the main indicators for price trends in the U.S. The chart below is an overlay of core CPI and core PCE since 2000.
Here is a long-term perspective from the actual beginnings of the two series.
Here is a chart that helps us compare the cumulative change in the two indexes since 1960. Over time, the PCE price index reflects significantly lower growth in inflation than does CPI.
For some technical data explaining the differences between the calculation of PCE and CPI, see this comparison article from the BEA.
In the real world, we can't exclude food and energy from our monthly expenses. But the extreme volatility of these two expense categories, especially energy, often obscures the underlying trend, which is the focus of the chart above. For evidence of the volatility, see this overlay of headline and core CPI and this one of headline and core PCE.
Hostility Toward Government Inflation Analysis
One the other hand, the volatile price of gasoline explains why so many people are angered by the exclusion of food and energy from core measures of inflation. The chart of gasoline prices below is based on the latest weekly data from the Energy Information Administration. As I write this, gasoline prices had fallen for 13 consecutive weeks, but now risen slightly for the past four weeks.
I'll update these charts shortly after the next PCE report is released.