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11 30 2015 | by Victor Xing | Economics

Why is the Consumer Price Index important?

The Consumer Price Index (CPI) was Federal Reserve’s preferred measure of inflation until 2000, when the central bank began to use Personal Consumption Expenditures price index (PCE) in its economic forecasts.

Consumer Price Index vs. PCE
Headline PCE (blue) vs. headline CPI (grey)

San Francisco Fed elaborated on the change in its December 2013 Economic Letter: Why Do Measures of Inflation Disagree?

The Bureau of Labor Statistics (BLS) first developed the CPI in 1913. The index is based on reports from retailers and tracks the price level for a basket of goods and services purchased by a typical urban consumer. The PCEPI is produced by the U.S. Commerce Department’s Bureau of Economic Analysis (BEA) based on the same national accounts data used to estimate gross domestic product. For most of its history, the Federal Reserve used the CPI to set policy and forecast inflation. However, in February 2000, the FOMC began using the PCEPI to frame its inflation forecasts.

The Federal Reserve further emphasized that in addition to PCE, policymakers continue to track a number of inflation measures including the CPI.  It is still a significant factor on U.S. monetary policy.

What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation?

Federal Reserve policymakers evaluate changes in inflation by monitoring several different price indexes. A price index measures changes in the price of a group of goods and services. The Fed considers several price indexes because different indexes track different products and services, and because indexes are calculated differently. Therefore, various indexes can send diverse signals about inflation.

The Fed often emphasizes the price inflation measure for personal consumption expenditures (PCE), produced by the Department of Commerce, largely because the PCE index covers a wide range of household spending. However, the Fed closely tracks other inflation measures as well, including the consumer price index and producer price indexes issued by the Department of Labor.

Moreover, alternative Consumer Price Index such as CPI-W (CPI for Urban Wage Earners and Clerical Workers) is used by the Social Security Administration for its periodic Cost-of-Living Adjustment.

Consumer Price Index - CPI vs. CPI-W
CPI vs. CPI-W

Next article11 29 2015 | by Victor Xing | Capital Markets

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