CPI vs. PCE Inflation: What Sets the Two Measures Apart

The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index both track consumer inflation, but they come from different agencies, use different formulas and weigh spending differently. The CPI is published by the Bureau of Labor Statistics (BLS). The PCE price index is published by the Bureau of Economic Analysis (BEA), as part of its personal income and outlays report. Anyone following PCE inflation or CPI inflation quickly learns that the two rarely match, and that the gap is explained by methods, not by one agency being right and the other wrong.

In brief

• CPI measures what urban households pay out of pocket; PCE covers a broader set of spending, including some paid on households’ behalf.
• The two use different index formulas and different weights.
• The Federal Reserve states its 2 percent longer-run goal in terms of inflation and has pointed to PCE as its reference measure, while the CPI drives many contracts and benefit adjustments.
• Differences in housing weight and health care coverage account for much of the typical gap.

Two indexes, two purposes

The CPI was designed as a measure of the change in prices for a basket of goods and services that urban consumers buy. Its household-based approach is a reason it is used in everyday contexts: wage negotiations, lease escalators, and, in the form of the CPI-W, the cost-of-living adjustments for some federal benefit programs. Its method is described in detail by the BLS, which draws weights from household surveys of what families spend and collects tens of thousands of prices a month.

The PCE price index starts from a different place. It is derived from the national accounts, the same framework that produces gross domestic product. The BEA builds PCE from business and government data on what is sold to households, not primarily from a household survey. Because it sits inside the national accounts, it is designed to be consistent with the broader measures of consumer spending that feed into GDP.

What each one counts

The BEA lists the main reasons the two measures differ. It groups them into four effects: formula, weight, scope and other.

Scope

The CPI measures households’ out-of-pocket spending. The PCE measure includes spending by and on behalf of the personal sector, which the BEA describes as including nonprofit institutions serving households. A clear example is health care. When an employer-sponsored plan or a government program such as Medicare or Medicaid pays a medical bill for a patient, the PCE counts that spending as consumption by the household sector. The CPI counts only what the consumer pays directly, such as premiums and copayments. As a result, health care makes up a larger share of PCE than of the CPI.

Weights

Weights decide how much each category matters. CPI weights come from the Consumer Expenditure Surveys, which record what households report spending. PCE weights come from the national accounts, which draw on business surveys and other sources. Housing is the biggest example of how this plays out. Shelter, which the BLS measures through rent and owners’ equivalent rent, takes up a considerably larger share of the CPI than of the PCE index. When shelter inflation is high, it pushes the CPI up by more than it pushes PCE.

Formula

The CPI uses what the BEA calls a modified Laspeyres formula, with a geometric mean applied within most item categories. The PCE index uses a Fisher-Ideal formula, which effectively updates the weights more flexibly as spending patterns change. Under a fixed-basket approach, consumers are assumed to buy the same mix even when relative prices change. A chained approach lets the index reflect that people shift toward items that have become relatively cheaper. In general, a chained measure can show somewhat lower inflation when substitution is strong, though the size of the effect varies.

Other differences

Seasonal adjustment methods, the treatment of particular prices and revisions also create gaps. One practical difference is that the CPI is generally not revised for the unadjusted index, while the PCE index can be revised as the BEA incorporates new data, sometimes for months and in annual updates for several years.

Why the Fed follows PCE

The Federal Open Market Committee (FOMC) states that inflation of 2 percent over the longer run is consistent with its mandate from Congress for maximum employment and stable prices. In its Statement on Longer-Run Goals and Monetary Policy Strategy, the Committee sets this goal, and the Fed has said for years that it judges progress using the PCE price index. The main reasons usually cited are the broader scope of PCE, the way its formula accounts for substitution and the fact that its history can be revised to correct for new information.

That does not make the CPI irrelevant to monetary policy. The CPI comes out earlier. The BLS typically publishes its monthly report before the BEA publishes the personal income and outlays report, and the Fed’s staff and financial markets use the CPI and the producer price data to estimate what PCE inflation will show. That is why economists often publish PCE forecasts in the days after the CPI release, translating the CPI components into their PCE counterparts.

Headline and core in both indexes

Both agencies publish a version that excludes food and energy. In the CPI, this is the index for all items less food and energy. In the PCE, it is the PCE price index excluding food and energy, often shortened to core PCE. The logic is the same in both cases: food and energy prices can move sharply, and some analysts prefer a read on underlying trends. The Fed watches headline and core measures, since headline inflation is what households ultimately experience and core inflation can offer a better signal about where prices are heading.

A simple illustration of the gap

Imagine a household economy with only two categories, rent and medical care. Rent is a large share of what households spend out of their own pockets, so it carries a large weight in the CPI. Medical care is largely paid by insurers and government programs, so only a small piece shows up as an out-of-pocket cost. In the PCE index, the medical spending paid by third parties is included, so medical care carries a much larger weight and rent a smaller one.

If rents jump and medical prices stay flat, the CPI will show more inflation than PCE, because rent matters more to it. If medical prices jump and rents stay flat, PCE will show more. Real data have hundreds of components, but the pattern is the same. The BEA’s own FAQ gives a historical case for a quarter in 2006 in which weight differences, with imputed rent on owner-occupied housing playing a major role, were the largest contributor to a 0.7 percentage point gap between the two annualized readings, while differences in scope partly offset it.

Common misconceptions

“One of them is the real inflation rate.” Neither is. Each answers a slightly different question. The CPI answers what the typical urban household’s out-of-pocket costs are doing. PCE answers what prices are doing across all consumption in the national accounts.

“PCE is always lower.” Often it has been, mainly because of formula and housing weight differences, but the relationship varies. Periods in which health care or other categories surge can narrow or reverse the gap.

“The Fed ignores the CPI.” It does not. The CPI is released first, widely cited and closely linked to PCE through its component prices. It is an input in the forecast, not a competing target.

“The two indexes use different prices.” Largely, PCE borrows many of its price inputs from the BLS, including the CPI and producer price index data, and applies its own weights and formula. The differences come as much from what is done with the prices as from the prices themselves.

Which one matters to you

For a household, the answer depends on what you are trying to learn. If your lease, labor contract or benefit adjustment refers to the CPI, that is the index that matters for the clause. If you want to understand how the Federal Reserve is likely to behave, PCE is the measure the Fed has named. For an economist comparing price changes with consumer spending or GDP, PCE fits better because it sits in the same accounts.

Where to find the data

The BLS publishes the CPI on bls.gov in a monthly report with detailed tables. The BEA publishes the PCE price index, including the version excluding food and energy, on bea.gov in its personal income and outlays release. The BEA also maintains a reconciliation of the two measures in research papers on its site, which is the most precise way to see how much each factor contributes in a given period.

FAQ

Which is higher, CPI or PCE?

Over many years the CPI has run higher on average, in large part because of how it weights housing and how its formula treats substitution. The ordering is not guaranteed in any given month or year.

Why does the Federal Reserve target PCE?

The Fed has pointed to PCE because it covers a broader range of consumption, accounts for changes in spending patterns and is consistent with the national accounts. The FOMC’s stated goal is 2 percent inflation over the longer run.

Who publishes each index?

The BLS, part of the Department of Labor, publishes the CPI. The BEA, part of the Department of Commerce, publishes the PCE price index.

Does PCE include health care paid by Medicare?

Yes. PCE includes spending on behalf of households, so medical care paid by insurers and government programs is counted. The CPI counts only out-of-pocket spending.

What is core PCE?

Core PCE is the PCE price index excluding food and energy. Core CPI is the CPI for all items less food and energy.

Can I use either index in a contract?

You can use whichever the contract names. Many private agreements and federal adjustments refer to a specific CPI series, so check the exact series and whether it is seasonally adjusted.