Most investors still rely on one measure of inflation—but the Federal Reserve has spent the past decade using another. In a year marked by runaway price pressure, this difference matters.
Inflation is at the top of all investors’ minds these days. It spurs fears of currency devaluation, sharply rising interest rates, and drained liquidity through quantitative tightening. Concern about runaway inflation—the opposite of transitory inflation—is driving Federal Reserve officials to discuss openly how aggressive they’ll be in transitioning to a restrictive monetary policy, starting with next month’s Federal Open Market Committee (FOMC) meeting. Markets are already ahead of the Fed, pricing in six 25-basis-point (bps) rate hikes in 2022.
The best way to measure inflation is an interesting question to consider as we prepare to spend the balance of the year fighting it. There are two standard measures of inflation in the US: the Consumer Price Index (CPI) and the Personal Consumption Expenditures price index (PCE), both of which are updated monthly. The Bureau of Labor Statistics (BLS) produces the CPI, while the Bureau of Economic Analysis (BEA) publishes the PCE.
Most of us are familiar with the CPI as the headline measure of inflation. It’s the index used to adjust Social Security payments, and it acts as the reference rate on financial instruments like Treasury Inflation-Protected Securities (TIPS). However, at the January 2012 FOMC meeting, the Fed declared it would use the PCE as its primary measure of inflation, viewing it as a more accurate gauge of price pressure across the broad economy. This is important because these indexes are calculated differently, therefore yielding different measures of inflation.