The Fed's preferred measure of inflation is changing

The personal consumption expenditures index for July, out next week, will be the last PCE report of its kind. The Bureau of Economic Analysis is adjusting how inflation is calculated — a curious change coming at a critical time, as the Federal Open Market Committee becomes increasingly divided about how to get inflation down to its 2% target.

The BEA does regularly reevaluate its PCE methodology. And it’s not uncommon for the agency to make changes in the fall.

“BEA is revising its recipe based on how the world is changing,” said Munseob Lee, an economist at the University of California, San Diego.

For instance, the BEA is adjusting how computer software and accessories are calculated because demand for AI has sent prices soaring. It’s also making changes to investment and legal services categories.

“I believe this change is going to make the PCE more accurate, giving a clearer picture to central bankers,” said Lee.

Economists expect these changes to lower the PCE inflation reading by 0.1%-0.3%. Right now, with the old formula, PCE sits at 3.7%.

“The reason why people are focused on it a little bit more is that you have an administration that has been talking about how they need to get inflation down,” said UBS economist Alan Detmeister, who used to work at the Federal Reserve. “They’re focusing so much on these items that are pushing up inflation at a time where the administration has wanted the Fed to lower interest rates.”

The lower inflation appears, the easier it is for the Fed to cut, or at least not hike, interest rates. The new PCE methodology could buy the Fed some time.

“We really don’t know exactly what the impacts are going to be,” said Detmeister. “So it is a little bit of a black box.”