Personal Consumption Expenditures (PCE) Price Index

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Definition of Personal Consumption Expenditures (PCE) Price Index: 

The personal consumption expenditures (PCE) price index measures inflation by measuring the price changes of consumer goods and services. 

Detailed Explanation:

The personal consumption expenditures price index (PCE price index) and the consumer price index (CPI-U) are the two most commonly quoted measures of inflation. The CPI is released by the Bureau of Labor Statistics (BLS). Social Security and many contracts are adjusted using the CPI. The PCE price index receives less publicity than the CPI, but it is probably the more important measure of inflation. The PCE is more influential in far-reaching economic policy decisions because it is preferred by the Federal Reserve when determining its monetary policy. The Bureau of Economic Analysis (BEA) calculates the PCE price index and publishes it monthly in its Personal Income and Outlays report.

The PCE price index is approximately 0.3 percent lower than the CPI. What accounts for the difference? While the two indexes use much of the same data, the different values result from the way the indexes are calculated. The CPI assumes the basket’s contents are identical every month. (The basket contents are updated every two years.) The PCE price index tries to account for the substitution of items resulting from the relative differences in prices. For example, if the price of beef increases and consumers substitute chicken, the PCE index reflects the increase in the demand for chicken. This means the PCE basket is adjusted with less expensive items resulting in a lower inflation rate.

The CPI and the PCE price index both weigh expenditures according to how much consumers spend on a given category, but the weights differ. For example, the weight given to housing is more than the weight given to entertainment because most consumers spend more on housing than entertainment. Housing prices are given more importance by the CPI than the PCE price index. Differences in weighting result from the sources of data and different objectives. Business surveys are used in determining the weights for the PCE, and household surveys provide the data for the CPI. The CPI figure most commonly used is the CPI-U. It only includes “out of pocket” expenditures, or purchases made directly by households in urban areas. The PCE price index is more comprehensive than the CPI because it includes rural areas. The PCE price index also includes spending by third parties on behalf of households. Items, such as health insurance, that are purchased by businesses as a benefit to their employees are included in the PCE price index and omitted from the CPI. Medical costs paid by Medicare or Medicaid are not paid by households, so they are not included in the CPI, but they are included in the PCE resulting in health care being weighted more in the PCE than the CPI. The CPI is a key component of the PCE price index, but the PCE price index also considers the producer price index.

Both the CPI and the PCE price index have their own version of a “core price index” which excludes food and energy. Food and energy prices can be volatile, so a large short-term swing in one can lead to misleading information. The core indexes provide a more accurate picture of long-term trends. However, because people eat and fill up the tanks in their cars, the CPI and PCE price index gives a more accurate picture of what people spend than the core indexes. Read our monthly State of the Economy blog to monitor the PCE price index, the CPI, and the core indexes.

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