FinLit Newsletter 9-29-2023

PCE index cools slightly today – understanding how to deal with economic and financial data

The PCE index (Personal Consumption Expenditures) cooled slightly in August compared to July, receiving a positive reaction from the markets today. The Fed has said the PCE is their “preferred” measure of inflation.

According to the Bureau of Economic Analysis (BEA), the PCE is “the value of goods and services purchased by, or on the behalf of, persons who reside in the United States”.

This sounds an awful lot like the CPI. Why do we have the PCE when we recently had the CPI just last week?

There are a few differences between the two indices:

  • Scope – the PCE has a broader population, measuring consumption habits of individuals plus some institutions such as nonprofits serving households. The CPI measures urban consumers, aiming to focus on what a typical American household spends.
  • Underlying basket of goods – The CPI uses a fixed basket of goods and services. The basket is updated periodically over the longer term to reflect typical spending habits of a household, but on a short term basis the basket remains relatively constant over time. The PCE on the other hand uses a “dynamic” basket of goods and services, with annual adjustments to the weighting of items. Its goal is to be adaptable to shifts in consumer behaviors
  • Sourcing – the CPI is based off household and business surveys, while the PCE draws on a range of sources, mostly government and business account reports

So you can see that while they both generally aim to measure price increases, broadly speaking, they go about it in different ways.

It’s important to understand that the CPI does not equal inflation, and the PCE does not equal inflation. Inflation is an abstract concept. The CPI and the PCE are data points that help us understand an abstract concept like inflation. The landscape of finance and economics is littered with concepts where the idea is easily conflated with the underlying supporting data.

This is what the Fed aims to do, and Jerome Powell says this often in his speeches, that they try to weigh a wide range of data points. So when conceptualizing and analyzing any complex topic like inflation, consciously take the time to understand the difference between what is a factual data point, and what is the concept or issue you are trying to understand.

There are a few potential paths forward here for prices:

1)  Inflation coming down

2)  Inflation “sticky”, staying elevated above target levels

3)  A contractionary environment or some crisis (remember we’re still concerned about credit profiles) that would create worsened price instability

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