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Why the CPI doesn’t figure in the Fed’s calculations

Tim Fitzsimons May 22, 2015
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The Consumer Price Index rose by 0.1 percent last month, according to figures out Friday. You could think of it as one more piece of evidence in the “no inflation” pile.

The CPI is used for a variety of things, particularly in adjusting rent and wages, as well as “in private contracts to escalate values of money … by the government … to adjust social security, and so forth,” says Steve Reed, an economist at the Labor Department’s Bureau of Labor Statistics who works on the CPI.

But the CPI isn’t what the Federal Reserve looks to when it tries to figure out whether the economy as a whole is experiencing inflation. The Fed prefers the Personal Consumption Expenditures index, or PCE.

Jeremy Siegel, a finance professor at the Wharton School at the University of Pennsylvania, says both of the measures’ “headline” numbers are inaccurate, “and the reason for that is when the price of one good goes up, we substitute it with other goods.” For instance, if beef gets expensive, you’ll probably just buy some chicken, and your quality of life will not suffer much (if at all).

That’s why the Fed looks not at the headline PCE, but the core PCE, which is the PCE with the volatile prices of food and energy stripped out. Ben Friedman, an economics professor at Harvard, says the Fed is just trying to influence the economy where it can.

“They’re letting the economy respond to movements up or down in oil prices rather than having monetary policy do that,” he says.

The PCE and its core number — will be released on June 1.

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