Inflation measures the rise in the general level of prices, and I would like you all to think about the role that certain prices play in thinking about inflation. Gas prices are one of the most visible prices around, and people consistently confuse them with overall inflation. However, energy prices are certainly important to many people in everyday life, and if they remain elevated for extended periods general consumer prices are likely to rise as a result. On the other hand, some prices like clothing have fallen in recent months. What we don’t see in inflation numbers is a shift in behavior. As gas prices rise, or clothing prices fall, people are allowed to reallocate their expenditures in the basket of goods they consume, but the CPI does not perform that reallocation. It also appears that the U.S. is better able to handle an increase in fuel prices at this time than we might have been able to handle the increase several years ago.
Questions you might try to answer (Just worry about answering ONE of these questions or ONE of your own related to the topic):
- Explore specific categories of prices in the CPI for recent increases or decreases, and relate that to the importance it has in the everyday budget. Are there some goods that are very visible that might drive people’s perception of inflation higher even though overall inflation is not very high? See the BLS site (http://www.bls.gov/news.release/cpi.t02.htm) or the St. Louis Fed (http://research.stlouisfed.org/fred2/release?rid=10) for detailed information. I would like you to report numbers to support your claims. On the St. Louis Fed site, once you click on a category, you can change the view from levels (which is an index) to rates of change (inflation) by going to “Units: Levels” under the graph and selecting “Chg. from Yr. Ago” as the units. Now your graph is in annual rates of inflation rather than an “obscure” index value. See an example here and here for a before and after.
- As people shift their consumption patterns over time, the rates of inflation we measure are influenced because of the fact that there is no substitution in the basket used to estimate the CPI. The Consumer Expenditure Survey provides updated information on what people are spending their money on. If you look at housing, why are people spending less on housing now than they were a few years ago? How might this be incorporated into our measures of inflation? What about other things like cell-phone versus landline phone service? Do these changes make it difficult to measure inflation on aggregate, and might this lead to some of the misunderstanding regarding what is reported as inflation?
- The Fed uses a different measure when discussing inflation called the Personal Consumption Expenditures (PCE) index that differs from the CPI. Why might we prefer to use this index to the CPI? Find a reputable (non-Wikipedia) source to refute your claims? Do you think this also leads to some confusion about what constitutes inflation?
The CPI, Consumer Price Index, and the PCE, Personal Consumption Expenditures differ in four areas and these explain the differences in growth rates between the two. These four areas include formula effect, weight effect, scope effect, and seasonal adjustment differences, price differences, and residual differences. The formula effect calls attention to the different formulas used to calculate each index. The Fisher-Ideal formula used to calculate the PCE, and the modified Laspeyres formula is used for the CPI. The main difference between the two is the amount that they take into account substitution among items as the price changes. Consumers substitute away from items with prices that rise rapidly, and they substitute towards prices that rise less rapidly. And the Fisher-Ideal formula better reflects the substitution; however, it is difficult to calculate because it requires data from expenditures for the most recent period and often times that data is not available. Which makes me believe the PCE is more accurate. The weight effect takes into account that the CPI is created from household surveys and the PCE is calculated from business surveys. The scope effect plays into the fact that the CPI measures out-of-pocket expenditures and the PCE measures the goods and services purchased by individuals and non-profit institutions. The PCE includes things like medical care provided by employers and things like Medicare and Medicaid. Another big difference is the fact that the PCE is recalculated on a quarterly basis whereas the CPI is fixed for a two-year period. I think that we might prefer this index because it is more frequently calculated, takes into account substitution of goods, and it measures things like Medicare and Medicaid and health insurance provided by the company one works with. I think the differences between these two surveys can cause people to be confused about what constitutes inflation because they use different formulas and take into consideration different aspects. Also the CPI places a much heavier weight on housing and shelter whereas the PCE places a much heavier weight on medical care and accounts more heavily on extra goods and services not included in the expenditures. This makes me consider the question is one better than the other? And it makes me wonder why the CPI is only evaluated every two years when the PCE is evaluated quarterly. I think since the PCE is evaluated quarterly it would have a more accurate depiction of the inflation.
“Comparing the Consumer Price Index and the Personal Consumption Expenditures Price Index” by Clinton P. McCully, Brian C. Moyer, and Kenneth J. Stewart in the November 2007 Survey of Current Business
Many people believe the CPI to be a clear indicator of inflation. The Consumer Price Index can give a loose representation of inflation if looking across a variety of goods, but I feel that this index does not give an accurate representation. There are variables that would affect the prices of everyday consumer goods on the CPI that are not related to inflation. For example, if storms ravage corn crops in the Mid West it would cause the price of corn to dramatically rise. If you followed the Consumer Price Index you would see this rise in price, and immediately come to the conclusion that your dollar would buy less corn than it did before (inflation). For this reason I feel there are lurking variables that affect the CPI that are not related to inflation. The CPI should be used as a general reference, but not as an indicator of inflation.
The CPI is used to measure the rate of inflation. To do this we must keep the same items in our “basket of goods” without substitution, even though people shift their consumption patterns over time. Luckily we have the Consumer Expenditure Survey (or the CE) to provide updated information on how people are spending their money. For instance if you look at housing you will see that people are spending about 2% less in 2010, as compared with 2009. This could be caused by the high mortgage rates for expensive housing and that many people are unable to afford such high rates. The CE shows that people are spending less money while paying their mortgages which results in a drop in spending in housing. Also a high unemployment rate may also result in people not being able to pay as much on their mortgage. This incorporates into our measure of inflation because housing is a large aspect of the CPI and since CPI is used to measure inflation, it may seem like inflation is not as high as it really is because a large component is declining. Other things like cell-phones have increased from $200 annually to $710 annually since 2001. While landlines have dropped from $700 annually to about $400 annually since 2001. This shows that people find it increasingly important to stay connected and find that having the newest and best phone is extremely important. These changes do make it difficult to measure inflation because people’s demands for certain goods are changing while the basket of goods remains the same. Since new technologies are also being invented it may be hard to find a substitute good if the government feels the need to add it to the basket. These changes may lead to misunderstandings about the reported inflation because they are increasing (with phones) and decreasing (in housing) so the true inflation may not be the number being reported. Customer demands and unemployment play a large role in what is being bought, which the CPI does not account for, therefore the true inflation rate may not always be getting reported.
To measure a change in prices that consumers pay on the goods they consume, we use two major index programs: the CPI (Consumer Price Index) and the PCE (Personal Consumption Expenditures). The reason why the CPI and PCE may not give the same measure of price change over time is a result of a few factors. The first notable difference is a difference in the formulation of the indexes. The CPI uses a fixed weight Laspeyres price index. The PCE deflator is the average of the Laspeyres price index and Paasche price index. Since the Paasche price index usually lies below the Laspeyres price index, the PCE measures less inflation than the CPI. The CPI and PCE differ in their scope. The PCE measures goods and services purchased by people and non-profit institutions. The CPI on the other hand measures out-of-pocket expenditures of urban households. In short, the PCE may include goods that completely out of scope of the CPI. Military clothing, final expenditures by museums and libraries, and food consumed on farms are all examples of items that could be included in the PCE. PCE also includes expenditures by employers, which is the next underlying issue between the two. Private market and business expenditures will have a stronger weight in the PCE, while everyday products used by households will weigh heavier on the CPI.
In regards to prices overall, the CPI proves to be the better index, seeing how prices on some goods and services must refer to the CPI index. Concerning the issue of what constitutes inflation, neither the CPI nor the PCE are the best possible options for measuring price change, yet they are both useful in their own aspects. CPI certainly represents the consumption of the average household most accurately of the two price indexes, not taking into consideration private market expenditures. While the PCE does take into consideration the substitution effect of goods, which therefore compensates for changes in preferences that may relate to technology or other factors, it is deflated through its formulation. Because of this, the PCE might not represent an accurate change in prices for everyday household goods as well as CPI.
Sources:
1.) An Examination of the Difference Between the PCE Deflator and the CPI
By Dennis Fixler and Ted Jaditz
http://www.bls.gov/osmr/pdf/ec020100.pdf
2.) A Comparison of the CPI and the PCE Price Index
By Todd E. Clark
http://www.kc.frb.org/publicat/econrev/PDF/3q99clar.pdf
The CPI can be misleading to people who are not completely aware of what exactly it measures, or if they have no knowledge in economics. For example, Americans spend a good amount of their funds on transportation, so if the price of metal rose because of some odd reason, then they would think inflation would rise dramatically. Thus, thinking the value of their dollar to decrease when it comes to metal. But this is not always the case, because if the price of metal rose, then say the price of cotton decreased, then essentially the value of the dollar would stay the same. I think the CPI is relevant in some aspects, but not to measure inflation.
We might prefer to use the PCE over the CPI because it depicts a better-fit percentage of our price stablility than the CPI. In fact, Charles Steindel reporting in 1997 for the “Current Issues in Economics and Finance” admits that the CPI overstates inflation by as much as one percentage point each year. Secondly, the CPI is a monthly measure that is released three weeks after the end of the month, only to be revised to account for seasonal adjustments. However, the PCE is continually revised and is released a week or two even after the CPI is released, and goes beyond seasonal adjustments to account for changes in estimates of consumer spending patterns. A close example of the differences between the CPI and PCE is one dealing with medical costs. The CPI includes out-of-pocket medical costs while the PCE includes entire household medical expenses. Moreover, Steindel notes that the PCE is a better measure of the average overall pace of inflation, while the CPI detects period-to-period changes. However, even though the CPI has it’s problems, and the PCE has been growing more slowly in recent year, the PCE has shown more drawbacks than the CPI. And ironically, the PCE does take some prices for individual items as gauged by “expenditure share,”from CPI data–about three-fourths of prices as stated by Steindel. This use of the PCE can be confusing because many who do not typically follow inflation rises or decreases, or total expenses v. individual purchases, are confused as to what is actually causing the change and how the PCE can be better if it is associated with the CPI to some extent.
There are a number of differences between the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE). The formula effect explains that the CPI uses a Laspeyres formula, which takes into account the price of goods and services by a urban family, usually with four members. The PCE uses the Fisher-Ideal formula which takes into account consumer substitution of a good when the price of that good increases. This is difficult to calculate because the information for the PCE index needs to be recent. In my opinion, the PCE is a better index because it is more accurate of a normal consumer. For many people, if a good increases they will substitute that good for a better priced good. It also maybe preferred to use the PCE because of the scope effect. The CPI measures the expenditures of a typical urban family, while the PCE uses goods and services consumed by every type of household and nonprofit institutions. Families change and adapt to their surroundings and the CPI is too formal of a calculation inflation. The PCE is more elastic and adaptable to changes that consumers make on a routinely basis. This definitely leads to confusion about what constitutes inflation because inflation just means an increase in prices from year to year, it does not state what specific prices from year to year. The PCE and CPI include different goods, so that’s where the average person could get confused on inflation.
http://www.bls.gov/opub/focus/volume2_number3/cpi_2_3.pdf
When a consumer unit (CU) spends their money on a good or service, the quantity that they purchase of the good may increase or decrease depending on the relative prices of other goods or services similar to the said good. Consumers tend to change how they spend their income based on the changing prices of goods. A consumer may prefer to buy “A” brand of a pizza if the price is $10 one month compared to “B” brand of a pizza whose price is $15. The PCE index tracks the consumer’s spending habits on pizza quarterly, where the CPI only tracks the consumer’s spending habits of every two years. The PCE may be preferred due to the fact that it is updated more frequently, therefore being more consistent in representing a consumer’s true consumption of goods and services. The CPI is less accurate in that it often exaggerates inflation. The PCE uses a broader variety of goods and services in its market basket, where the CPI uses a fixed basket. A report by Humphrey-Hawkins states that the PCE method of inflation measurement “avoids some of the upward bias associated with the fixed-weight nature of the CPI.” There is an especially large gap between the two measures of inflation, shown in a graph posted in an article online, which shows the CPI for December 1990 at 6% and the PCE at around 4.7%. That is a considerable difference. However, despite the differences in the results of measures of inflation, the PCE does in fact share data with the CPI. The Humphrey-Hawkins report states that “the chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI.” The fact that the PCE derives data from the CPI may cause confusion to people because the PCE and CPI use different goods and services to an extent, and the cause of the actual inflation change may be unclear.
I forgot to mention my source…
Source:
Meet The Fed’s Elusive New Inflation Target
By: Elizabeth Stanton
http://www.thestreet.com/markets/marketfeatures/889679.html
Although the CPI is used more than PCE, it is not always the best measurement of inflation. The CPI can be biased and does not necessarily represent inflation in its entirety. Unlike the CPI, the PCE takes into account the fact that the basket of consumers products changes constantly. The PCE allows the basket to change every quarter whereas the CPI has a fixed basket that is updated every two years. Due to the fact that the CPI uses the same products in the basket for longer periods of time, it is not able to measure the rate of inflation as well as the PCE and tends to be broader than the PCE in its measurements. Although the PCE offers a more accurate rate of inflation, the Fed uses a subcategory of the PCE which does not take into account food and energy prices. It is believed that the price of food and energy may change due to reasons other than inflation and are therefore not counted. This may not give a clear view of the rates of inflation.
Source:
Hubbard, R. Glenn., and Anthony Patrick. O’Brien. Macroconomics. 3rd ed. Upper Saddle River, NJ: Pearson Prentice Hall, 2010. Print.
In today’s society, the tastes of people are always changing and changing quickly. New technology is always coming out, and many people in society always want the newest iPhone or the newest computer. This poses a problem when it comes to calculating the CPI or Consumer Price Index. Like Lori Haskins said the CPI measures the rate of inflation. The Consumer Expenditure Survey is sent to households to calculate what is included in the basket that is presented. This process creates a basket of goods that is used to be compared to the same basket later on down the road. But the problem comes in when the items that were used in a specific basket are not being used anymore, and are substituted by another item. This becomes evident in the landline verses cell phones. The landline price has dropped dramatically while the cell phone prices have risen greatly. If this change is not included in the basket of goods then the information that is presented is invalid due to factors outside of inflation effecting the change. Another factor is that new appliances that first come out usually are priced higher at first, and drop price dramatically as time goes on. This has no correlation to inflation. For example, in an article written by an msnbc writer, Bob Sullivan says, “A look at 1971 Sears catalog offers a glimpse of some plummeting prices. In 1971, a basic Sears refrigerator cost $399. Adjusted for inflation, that would be about $2,000 in 2005 dollars, or nearly seven times the $297 price of a basic fridge in today’s Sears catalog.”(Sullivan 1). All of these factors must be taken into consideration when looking at the comparisons of CPI. For housing, Lori spoke a lot about the reasons for spending less on housing than they were a few years ago. This could be due to the higher unemployment, making it harder to pay mortgage bills. In summary, the CPI can tell a lot about the trend of inflation, but it should not be the sole determination of inflation due to the many misunderstandings in the reports.
Sources
Life is harder now, some experts say
http://www.msnbc.msn.com/id/21309318/ns/us_news-gut_check/t/life-harder-now-some-experts-say/#.T2kjtxES2Ag
The Consumer Price Index (CPI) and the Person Company Expenditures (PCE) are both measurers and indicators of inflation. They are very similar in comparison however there is one main point that makes them vastly different.
Recently in our economy gas prices have risen drastically over the past few months. With this increase in gas, there has been a comparable decrease in clothing prices. This allows for a different allocation of our resources. We can buy more clothes with the money we used to purchase them before and less gas with the money we put aside for it.
According to the CPI, we allocate 4.9% of our income towards clothing and a 17.9% towards gas. The CPI measures the same fixed basket of goods with weightings that do not change over time. So when gas prices go up, we are still purchasing the same 17.9% of our income which wouldn’t give us the same amount of gas that we require and the same $4.9% of our income for clothing which would give us more clothing then we need.
At times like these, this is when the PCE is a really good indicator. What the CPI doesn’t do and the PCE does is it takes into account a consumers’ changing consumption due to fluctuating prices. So in this same scenario with a rise in gas prices and a fall in clothing prices, the PCE will for example have 3.9% of our income for clothing and adjust the gas to take up about 18.9% of our income.
The CPI and the PCE are both very good indicators of inflation. They both move along the same pattern. The CPI tends to be higher than the PCE, however, that’s only because the BEA takes into account a reallocation of resources.
Sources:
http://www.investopedia.com/terms/p/pce.asp#axzz1plYrVb9I
http://www.bls.gov/osmr/pdf/ec020100.pdf
The Consumer Expenditure survey is a great place to start to understand what people are spending their money on, and maybe shed some light on why certain prices are rising or falling. When you look at housing, mortgage interest payments and charges fell by 6.8%, which as stated on the survey’s website, gives “evidence of the continued weakness of the housing market in the nation”. In my opinion, Americans are spending less on housing because after the housing bubble burst, many people are having difficulty securing loans because banks are far less trusting than before. Also, potential house-buyers themselves may be weary to enter the housing market because they know what happened just a few years ago and how volatile the market is right now. With topics like cell phone service versus landline service, landline telephone companies are finding it difficult to keep up with cell phone service providers, because cell phones are taking their place in homes and businesses. Situations like these should be incorporated into our measure of inflation because knowing the reason behind why a price is rising can be incredibly useful in dispelling fears of inflation. These changes can make it difficult to measure inflation accurately however, and since many people are eager to blame inflation as the culprit for a rise in price, this can lead to misinformation about inflation in America.
Buried in the Fed’s Monetary Policy Report to the Congress on February 17th, 2000, the Federal Reserve stated that they would change their former policy of using the CPI to measure rates of inflation, to what is being used now, the PCE index. The reason for these changes was because “the PCE index was constructed from a formula that has the ability to reflect the changing composition of spending and thereby avoids some of the upward bias associated with the CPI.” There are many reasons why people may prefer to use the PCE index, as opposed to the CPI. One of the main reasons is that they are calculated differently. The CPI approaches inflation by looking at a “basket of goods” and comparing it over time. “Many economists have pointed out that this approach is too simplistic and overestimates the actual cost of living.” The PCE index uses more complicated mathematical formulas, which take changes to the “baskets of goods” in account, such as price increases that can lead to substitution between goods. This way the overall amount of inflation “is spread out and more accurate.” Another key difference between the CPI and the PCE that can persuade people towards using the PCE, is that once the PCE is announced, it is still subject to change. While this can potentially become a tool to help make the PCE much more accurate than the CPI, some may argue that it would not be as useful to adjust “consumers’ income payments, (for example, Social Security) or to adjust income eligibility levels for government assistance.” Overall, it would be more beneficial on a whole to have an index that was accurate when making critical changes to those policies. While people may become confused about what really constitutes inflation by having these two indexes, but the indexes mainly take the same things into consideration and calculate them differently.
http://www.federalreserve.gov/boarddocs/hh/2000/February/FullReport.htm
http://www.bls.gov/dolfaq/bls_ques1.htm
http://conversableeconomist.blogspot.com/2012/01/consumer-price-index-vs-personal.html
The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) are two variances on measuring inflation in the economy. According to Brent Meyer’s 2010 article “What’s up with the Gap between the Core PCE and Core CPI?” some find the PCE to be a better indicator of inflation due to the fact that it “takes a somewhat broader approach, not only attempting to measure spending by households, but also by nonprofit institutions serving households. This amounts to the inclusion a variety of nonmarket prices such as financial services furnished without payment, insurance premiums, and social assistance services.” For example, the PCE price index accounts for government and employer-paid medical care services, while the CPI only incorporates out-of-pocket medical care expenses. The PCE is also calculated through a Fisher-ideal formula that allows the PCE to be more flexible and allow for substitution bias. The CPI is calculated through a Laspeyres index which according to Meyer “makes the CPI a “fixed-weight” price index, with the relative importance (or weight) of each item in the consumer market basket being adjusted for expenditure changes only every two years”. Due to the differences in the extent of the measures and in the source data for some items, the PCE and CPI have different weights on similar items. Meyer states that “the largest difference comes from the shelter (housing) components, which in the CPI carry a relative importance value of roughly 32 percent, while in the PCE it is a little less than half of that”. Such a large difference in weights means that housing prices are more of an influence over the outcome of the CPI than that of the PCE, leading to differences in their growth rates over time. These major differences could possibly lead to confusion as to what constitutes inflation. This confusion could arise from the fact that people generally do not account for inflation on expenses that are not paid out-of-pocket but the PCE does take such expenditures into account which leads to a higher PCE inflation rate. Another reason for confusion could be that the PCE does not include food or energy prices in its projections which are two goods that are constantly hawk-eyed by the public.
Consumer price index is an average of the prices of the goods and services purchases by the typical urban family of four. By using CPI, we can measure the changes in the price level over time. Thus, it is the most widely used measure of inflations. But, the CPI usually overstates the true inflation, which makes it inaccurate. This happens from the substitution bias, increase in quality bias, new product bias, and outlet bias. Another form of measuring inflation is the personal consumption expenditures. This is a measure of the price level expect it includes only the prices of goods from the consumption category of GDP. There are some advantages in using the PCE over the CPI, first, the PCE is a “chain-type” price index in that it allows the mix of products to change each year, but the CPI uses a “market-basket” approach which will cause the inflation to be overstated because consumers shift the mix of products they buy each year. Another advantage in using the PCE is that it includes the prices of more goods and services then the CPI, therefore making it a more inclusive measure of inflation. Lastly, the Fed can keep better track of historical trends in the inflation rate using the PCE because past values of PCE can be recalculated. There can be some confusion about what constitutes inflation if we used the PCE over CPI. This can happen because people will not know what prices are being included in these price indexes. The PCE does not include food and energy prices, which can confuse people if they did not know this.
SOURCE:
Hubbard, R. Glenn., and Anthony Patrick. O’Brien. Macroconomics. 3rd ed. Upper Saddle River, NJ: Pearson Prentice Hall, 2010. Print.
If you look at the changes for food prices on the St. Louis Fed graph in 2011 and compare that to a year before (2010), you can see that the prices raised significantly, about 10%. This happens about a year after the end of a recession. People would see that the prices are rising significantly, and would assume that this is due to inflation. However, this is not the case, because if you look at the graph for ALL goods (on the same website), you can see that there is only about a 3% overall rise in prices (I say about because it is difficult to determine the exact extent of the 2011 raise). Some people might have thought that inflation was about 7% higher than what it actually was if they were to just look at food prices. This increase in food prices could be from something not related to inflation, such as droughts.
“Economic Research – St. Louis Fed.” Economic Research. Federal Reserve Bank of St. Louis. Web. .
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s%5B1%5D%5Bid%5D=CPIAUCSL&s%5B1%5D%5Btransformation%5D=ch1
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s%5B1%5D%5Bid%5D=CPIUFDNS&s%5B1%5D%5Btransformation%5D=ch1
Many people use the prices of important goods in order to judge the amount of inflation. Gas prices are probably the most common measure of inflation because gas fuels the American economy. The Federal Reserve measures inflation by using the Personal Consumption Expenditures (PCE) index which is different from the Consumer Price Index (CPI). The main difference between the PCE and CPI is the range that each one looks at. The CPI measures the expenses of the consumer while the PCE is broader in that it also attempts to look at the expenses of the consumer plus the non-profit services to the households such as employer-paid medical services. The other main difference between the CPI and PCE is the weighted importance of each item. The CPI adjusts to expenditure changes every two years while the PCE is continually adjusting to expenditure changes which give a better indicator of inflation. At its core, inflation is the level of price changes, and looking at the PCE versus the CPI can lead to confusion about what constitutes inflation because they both weigh items differently based on two different surveys so inflation may seem greater in one index versus the other simply because of the weighted importance. This difference between the CPI and PCE also makes it difficult to know if certain price increases are just noise that should not be looked upon with great importance or if they are an indicator of the future.
Sources:
What’s Up with the Gap between the Core PCE and the Core CPI
By Brent Meyer
http://www.clevelandfed.org/research/trends/2010/1110/01infpri.cfm
Comparing Price Measures- The CPI and the PCE Price Index
By Brian C. Moyer
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
The PCE is a measure of price changes in consumer goods and services. A personal consumption expenditure (PCE), consist of the actual and imputed expenditures of households. These measures go on to include data pertaining to durables, non-durables and services. It is essentially a measure of goods and services targeted toward individuals and consumed by individuals. However, a CPI only measures the weighted average prices of a “basket” of consumer goods and services such as transportation, food, and medical care. The CPI is calculated by taking the price changes for each item in the predetermined “basket” of goods and averaging them. These changes are used to assess the price changes associated with the cost of living. We might prefer to use the PCE method of inflation because it holds a more accurate depiction of inflation. The CPI method uses only a select amount of goods and services to provide us with inflation changes. I do believe these two methods of calculating inflation leads to confusion about what constitutes inflation. I believe people can become confused when calculating these two different formulas.
There are several noticeable differences when comparing CPI (consumer price index) and PCE (personal consumption expenditures), which I believe puts the PCE above CPI as an index for measuring inflation. The biggest noticeable difference between the two is their range. The CPI measures the money spent straight out of the pockets of the average consumer, while the PCE is much broader, measuring spending by households, and also nonprofit institutions serving households. Because of this, I believe that the projected inflation of the PCE is much more accurate than that of the CPI index. The second major difference between the two indexes is their formulas. Then CPI is calculated using the Laspeyres index, while the PCE is calculated using the Fisher-ideal index. The use of the Laspeyres index makes the CPI a “fixed-weight,” with the items in the consumer basket being adjusted for expenditure changes every two years. I believe this is another reason for why the PCE is the more preferred index of the two. The PCE is continuously updated for expenditure changes. The CPI index does not allow for substitution effects. One example of this substitution effect would be if the price of energy drinks suddenly doubles, causing people start drinking more soda. After this takes place, the CPI might tend to overstate the aggregate price level during random periods of price changes. The last major difference between the two indexes is called the “weight” effect. This refers to the fact that CPI and PCE put different weights on different items and might value one item more then the other. The largest difference is seen in the housing components, which the CPI holds fairly high (32 percent) compared to that of the PCE (which is a little less then half of 32 percent). Such a large difference means that the housing prices exert a lot more influence over the projected CPI then that of the PCE, which then in turn leads to higher growth rates over time.
Sources: http://www.clevelandfed.org/research/trends/2010/1110/01infpri.cfm
: http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-pce/
By: Ryan Taylor
The CPI measures inflation but it does not account for people reallocating their expenditures when they prices rise and they are forced to spend their money elsewhere. Inflation is measured by the CPI by what we spend on items in our “basket of goods.” However it does not change according to rising prices and substitution of goods, it does not show us a shift in behavior. However, the Consumer Expenditure Survey gives in detail, an overview of spending. If you look at the CPI you will notice that annual housing expenditures decreased overall but the CE gives reason behind it. The effects of the recession still seen in 2001, resulted in a depressed housing market which explains the falling spending on housing. This changes and substitutions of goods make it difficult to accurately measure inflation. The basket of goods remains the same but people’s demands for different goods are changing. Technology is growing at a rapid pace but the newest technology is not taken into account in the basket of goods because it remains the same. Although the spending on entertainment is decreasing the CPI does not show what consumers are spending their money on instead. High gas prices are also cause for cut backs in spending in other areas, not listed in the CPI.
http://www.investopedia.com/articles/07/consumerpriceindex.asp#axzz1pngCGVcm
In terms of measuring inflation, there are two major indicators: CPI and PCE. Generally, Consumer Price Index (CPI) is well known to consumers. However, in terms of measuring in accuracy, PCE is better. PCE includes very specific details on spending, such as goods and services purchased by individuals, as well as non-profit organizations. Furthermore, when a company is purchasing products like healthcare, which companies purchase on the behalf of the household, it is counted as household spending and counts towards the PCE. In contrast, CPI only counts the spending that is made by individuals out of their own pocket. Not only does PCE count purchases on behalf of household, but PCE also counts products purchased without price value, such as free financial service.
The difference between the two indicators is not only in the calculation subjects of the indicators, but also in the manner the indicators are calculated. While the PCE’s basket is changed quarterly, the CPI has a stagnant basket for two years. However the market changes rapidly; changing the basket every quarter may sound excessive, but the reality is no one knows what will happen to the market tomorrow. Thus, in the perspective of the Fed, using the PCE gives a better measurement of inflation.
However the PCE may confuse some consumers who do not know what constitutes as inflation, thus most consumers use the CPI. However the flow of economy can never be measured perfectly. The study of economics and the calculation inflation are just estimates to get the best understanding of certain situations, and are not 100% reality.
Works Cited
Moyer, Brian C. “Comparing Price Measures— The CPI and the PCE Price Index.” Bureau of Economics Analysis. U.S Department of Commerce, 13 Mar. 2006. Web. .
Hakkio, Craig. “PCE and CPI Inflation Differentials: Converting Inflation Forecasts.” Kensas City Fed. Web. .
First, comparing PCE and CPI they are both used to measure consumer inflation. PCE focuses on the measure of changes in price of consumer services and goods, measuring the actual and expenditures of a household. Compared to this CPI focuses on changes in purchasing and cost of living of an average family. Now for differences, according to the journal An examination of the difference between the CPI AND THE PCE deflator, “The CPI is fixed weight Laspeyres price index, the PCE Deflator is derived from deflation by a Fisher Ideal quantity index” (Fixler and Jaditz 2). On top of that the two different measurements do not have the same components measuring programs, weighting, and measuring materials goods. The PCE goes more in detail for items that are not even in the CPI index, some examples are “Military clothing, final expenditures by museums and libraries, and good furnished and consumed on farms”(Fixler and Jaditz 2). Also PCE has greater weight in the Physicians category focusing on health care to employers, workers, and household. CPI on the other hand though “focuses on the out-of-pocket expenditures of households as determined from the Consumer Expenditure Survey”( Fixler and Jaditz 3). Now the main difference why people prefer PCE over CPI is how the formula affects the index, how “CPI uses fixed weight average prices for individual components, with the weights updated every two years. In contrast, the PCE index changes every quarter” (Hakkio 56). According to the journal PCE and CPI Inflation Differentials: Converting Inflation Forecasts, “Many analysts prefer the PCE price index to the CPI because its weights are updated more frequently” (Hakkio 56). Telling that if there is more frequent updates in the weights of the index that “better account for substitution between different components of the index as the relative prices for those components change”(Hakkio 56). This makes perfect sense in the business world if you update more the more accurate your data. Some confusion it could lead about the inflation is that According to journal reconciling the CPI and the PCE deflator, “The term “fixed-weight index” can mean two different things, the potential for confusion to exists”(Triplett 13). The CPI weight is fixed in a time series sense, but in the PCE they use fixed-weight index number formula, but the time-series sense is not fixed. The other confusing part I personally think is that PCE seems to be way better in measuring more accurate index than CPI, but CPI is more widely used. I personally think this is because of government time and labor wise. If they want to get more data they need to hire more workers for surveys data and if it’s done quarterly in a year(PCE) compared to 2year length(CPI) it will both result in more government spending.
Work Cited
Fixler, Dennis, and Ted Jaditz. “An examination of the difference between the CPI and the PCE deflator.”Division of Price and Index Number Research, Bureau of Labor Statistics. (1997): 47. Web. 21 Mar. 2012. .
Hakkio, Craig S. “PCE and CPI Inflation Differentials: Converting Inflation Forecasts.” Federal Reserve Bank of Kansas City. (2008): 68. Web. 21 Mar. 2012. .
Triplett, Jack E. “Reconciling the CPI and the PCE Deflator.” Monthly Labor Review. (1981): 15. Web. 21 Mar. 2012. .
The CPI (Consumer Price Index) and the PCE (Personal Consumption Expenditures) are calculated differently using different formulas to measure price change. The PCE is based on the Fisher-Ideal formula while the CPI is based on the Laspeyres formula. Both indexes are constructed based on different sources: household surveys for the CPI and business surveys for the PCE (Meyer 6). The CPI measures the price change of a specific basket of goods and services while the PCE uses a chain-weight Fisher Ideal formula to calculate the average of different fixed-weight measures of price change (Clark 16). The reason the PCE may be more accurate and comprehensive is because the formula used for the index takes substitution of goods more into account than the CPI and is calculated more frequently. If a price of a good goes up, CPI calculates a higher inflation rate. In reality, when the price of a good increases, consumption of that good tends to decrease while consumers substitute that good with another. The CPI does not take this factor into account unlike the PCE, therefore the CPI sometimes overestimates inflation rates. I think this may cause some confusion about what constitutes inflation since there are quite significant differences between the two indexes. Both can give us a representation of an overall price change, but neither can give us a 100% accurate answer.
Clark, Todd E. “A Comparison of the CPI and the PCE Price Index.” Economic Review (1999): 15-25. Web.
Laurence, Meyer H. “The CPI and the PCE Price Index: A (Former) Policymaker’s Perspective.” Web.
The Consumer Expenditure Survey states that mortgage interest payments and charges fell 6.8 percent from 2009-2010. This decrease in payments and charges is the result of the poor housing market. One cause of this is that when housing prices fell after their peak in the early 2000s, many people who had taken out loans when prices were high became underwater on their mortgages and unable to sell their houses. There was an abundance of foreclosures and people who could not sell their houses, leading to money loss for the lenders (banks). The instability of the housing market and number for foreclosures makes banks fear the unanticipated inflation rate and therefore not want to lend money to people to buy houses. The fact that many people have switched to cell phone over landline phone use exhibits how people’s consumption patterns change between years. If the CPI does not account for the increase in cell phone use, it seems as if the average amount spent on phones has drastically decreased. This is called the “new product bias” and it makes the CPI overestimate inflation. This can give people the misunderstanding that inflation is higher than it is, and in turn affect spending.
The change of CPI over the years spells out the state of inflation for people. The problem is that, while the United States has been in a recession, the CPI’s of specific goods and services creates an alarming perception for the public that only seems to tell of imminent economic disaster. If you look at the overall rate of inflation, prices are starting to revert back to their previous areas prior to the recession beginning in 2008. The annual percentage change of CPI for all items is at a stable 1.9 that has been relatively low over the previous months in 2012 and 2011. The annual rate of change of the CPI for gas of all types has changed from 20.2 and 19.8 months ago to a 5.9 in February (1). Since gas prices are one of the most visible prices for everyday consumers, seeing drastic changes in gas inflation would cause fear in the stability of the market. In reality, the real change in CPI has started to level out to around 6.5% compared to a -4.0 to 12.0% bipolar range in the middle of the 2008 recession (2). These changes in inflation, that are presented to the public, give off exaggerated notions that inflation is completely volatile like the everyday gas changes. The only true evidence comes from examination of real rates of change including all prices except volatile ones like gas and food.
Sources:
1) “Consumer Price Index for All Urban Consumers (CPI-U): Seasonally adjusted U. S. City Average, by expenditure category and commodity and service group”
By the Bureau of Labor Statistics
http://www.bls.gov/news.release/cpi.t02.htm
2) “Graph: Consumer Price Index for All Urban Consumers: All Items”
By the Federal Reserve Bank of St. Louis
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s%5B1%5D%5Bid%5D=CPIAUCSL&s%5B1%5D%5Btransformation%5D=ch1
The CPI is used to identify inflation but I don’t believe that it gives the most accurate reading of whether a price of a good rises due to inflation or perhaps to some other random variable. As an example look at the CPI for Urban Consumers: Gasoline (all types) from 2008-2010 according to the stlouisfed.org link and it should show the varying CPI going from more than 80 to dropping to less than -120 in less than two years. The high CPI represents inflation but the graph doesn’t show the reason for inflation besides the numbers counted up through the surveys to measure CPI. Gas prices are very volatile and affect other categories of products such as food in the grocery store since gas/fuel is required for transportation of this food to grocery stores across the country. Gas prices in throughout 2008 shocked many consumers as the prices for a gallon of unleaded fuel jumped to record highs (at the time) of $3.50 a gallon. Looking only at CPI during this year would indeed show inflation but it would only provide one reason for inflation. However, there were many other factors that contributed to high gas/fuel prices in 2008 such as drilling bans enacted just the year before as well as the fact that OPEC didn’t have to give oil to anyone for any reason at the time.
Hargreaves, Steve. “Who’s to blame for $4 gas.” CNN Money. N.p., 2008. Web. 21 Mar 2012. .
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s%5B1%5D%5Bid%5D=CUUR0000SETB01&s%5B1%5D%5Btransformation%5D=ch1
The Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) Index are both used to “measure” inflation. These two indexes use different formulas to do so, which causes each one to behave differently over time (McCully). So why would we prefer one to the other? I can think of a good reason as to why we would prefer to use the Personal Consumption Expenditures (PCE) Index over the CPI. First off, the CPI “excludes food and energy, as its key inflation measure” (Shulman). This exclusion sounds like a good idea at first because food and energy are seen as elements that fluctuate a lot, and so, this was enacted to avoid these elements from “driving the inflation rate” (Shulman). However, as far as energy goes, it’s prices haven’t been fluctuating randomly up and down, which would make sense to exclude it from the CPI; But instead, “energy prices have risen inexorably higher over the past four decades” (Shulman). In my opinion, this could be good reason to use an index that includes energy prices in its calculation of inflation. Now, to see this from all sides, I can also refute my claim to prefer the PCE Index. One reason is because housing is weighted far lower in the PCE index than in the CPI. Thus, “the incipient inflation in rents with be downplayed” using the PCE Index and it could solely be due to the fact that the “Fed is fearful that rising rents would make it difficult to maintain its zero interest rate policy going forward” (Shulman). With that said, I don’t believe downplaying rent for that reason is smart because it should only be downplayed if it doesn’t play a major role in inflation and so, the PCE Index has it’s downsides. Overall, I think the fact that these different indexes will exclude factors, of which seem important to inflation, brings about confusion as to what exactly inflation is.
Works Cited
McCully, Clinton P., Brian C. Moyer, and Kenneth J. Stewart. “A Reconciliation between the Consumer Price Index and the Personal Consumption Expenditures Price Index.” Sept. 2007. Web. 21 Mar. 2012. .
Shulman, David. “Federal Reserve Abandons Core Consumer Price Index.” US News. U.S.News & World Report, 26 Jan. 2012. Web. 21 Mar. 2012. .
CPI which is the index that gets more attention from people has major differences from another index known as the PCE of Personal Consumption Index. Differences between the two derive from many areas such as where the weights are from, the formulas used to create the index, and what the expenditures ultimately include. PCE offers more updated results and provides an outlook that is less concrete and more subject to change. Since PCE includes expenses are not just straight from the pocket it gives a better representation of the big picture. Another interesting disadvantage to the CPI is that it is not revised. When anything changes in the way the CPI is calculated changes no one goes back and recalculates historic CPI figures. PCE is revised and altered over time and changes are applied to past data as well, giving the PCE a more accurate indication of what is happening over time. This difference between the CPI and PCE absolutely leads to confusion about inflation rates. Since the CPI used fixed-weights and the PCE weights change every quarter it is hard to find a way to convert the two inflation rates. This problem also comes from the difference in their formulas. It makes forecasting inflation rates challenging and differences in the past have been around 0.3 and 0.5 in percentage points between the two and no easy way to create a common inflation rate.
Moyer, Brian C. “Comparing Price Measures— The CPI and the PCE Price Index.” Bureau of Economics Analysis. U.S Department
Taylor, Timothy. “CONVERSABLE ECONOMIST.” : Consumer Price Index vs. Personal Consumption Expenditures Index. 17 Jan. 2012. Web. 22 Mar. 2012. .ent of Commerce, 13 Mar. 2006. Web. .
Hakkio, Craig S. “PCE and CPI Inflation Differentials: Converting Inflation Forecasts.” Federal Reserve Bank of Kansas City, 2008. Web. 22 Mar. 2012.
The Consumer Price Index (CPI) is a measure of consumer purchasing power. In Neil Shah’s Wall Street Journal article “Energy Costs Boost Consumer Prices”, dated 3/16/2012, he states consumer spending is 2/3 of the United States economy. He also states adjusted hourly wages are dropping. Lower wages and higher prices in key consumer expenditure categories is a double hit to consumer purchasing power. This makes key components of the CPI more visible, but also more important. The visible and more important components of the Consumer Price Index are those components that consumers (individuals and families) cannot avoid buying on a regular basis. Looking at the Bureau of Labor Statistics CPI for All Urban Consumers Table 2, food, transportation, and housing are rising at about 4%, 7%, and 2% on average over the last six quarters. Individuals and families have to eat, get to work, and need a place to live. On the other hand, consumers can delay buying apparel, medical care, recreation, and education. The current low inflation rate is likely deceiving because of recent and unusual long-term declines in housing and a weak economy. In Brian C. Moyer’s, “Comparing Price Measures–The CPI and the PCE Price Index, both graphs show a consistent correlation between the CPI and the PCE, with the CPI slightly higher in most cases. However, I believe the CPI better tracks the key weekly and monthly expenditures that individuals and families cannot avoid.
Sources:
1) “Energy Costs Boost Consumer Prices” by Neil Shah, Wall Street Journal 3/16/2012
2) “Comparing Price Measures — The CPI and the PCE Price Index”, by Brian C. Moyer of the National Association of Business Economics Policy Conference, 3/13/2012.
3) “Consumer Price Index for All Urban Consumers”, Bureau of Labor Statistics, Seasonally Adjusted Annual Rate Percentage Change for Quarters Ending May 2011 to Feb 2012
The FED rather uses the PCE instead of the CPI for a number of reasons when dealing with inflation. One reason is that it provides more comprehensive measurements of inflation than CPI. Accordin to this article, “CPI inflation is about 0.3 percentage point higher than core PCE inflation”, this means that the FED would rather use something that is more realistic and exact when dealing with a very important economic subject such as inflation. Also the CPI and PCE are both calculated in different ways. CPI uses a fixed rate while PCE is updated every 4 months, thus giving an up-to-date measurement frequently. Also, weights for both methods are different. CPI reflects spending from urban people, while PCE focuses on households of everyone and some institutions. I think with these two methods of measurement there is some trouble with concluding inflation. One number in one method will be bigger than in the other method. And while yes they convert both methods back and forth with a formula, the FED wants to use easiest as possible method while economy looks at what is familiar. Inflation is tough to decipher with two methods butting heads.
source:
Craig S. Hakkio
“PCE and CPI Inflation Differentials: Converting Inflation Forecasts” 2008.
http://www.kansascityfed.org/Publicat/Econrev/PDF/1q08Hakkio.pdf
CPI is more familiar to individuals, but people may prefer to use PCE because of the advantages it has through the differences in: scope of components, weights, and formula. According to Chairman Bernanke, the PCE index is generally thought to be “the single most comprehensive and theoretically compelling measure of consumer prices” (Hakkio 51). While PCE focuses and weighs heavier on a “wider measure of goods and services for households and nonprofit groups” (Pettinger), CPI only includes the weighted average of what’s purchased by a typical family of four. The CPI is more narrow and disregards components included by the PCE such as “military, clothing, final expenditures by museums and libraries, and food furnished and consumed on farms” (Fixler and Jaditz 2). CPI components can be volatile due to random events, thus giving a “misleading indicator of spare capacity and underlying growth in the economy” (Pettinger). Moreover, PCE is a better form of accuracy when it comes to inflation. PCE can be confusing to people because it is calculated by the Fished-Ideal formula, which is more complicated to calculate. The average person will choose the simplest formula, Laspeyres formula for CPI, to calculate, but what people should know regarding this is the Fisher-Ideal formula takes substitution into account, unlike the Laspeyres formula. In addition, unlike CPI, a “fixed weight that changes every two years,” (Hakkio 56) PCE weight changes each quarter allowing for data accuracy to increase. The majority of people have the same mindset about the definition of inflation and they disregard the inflation rate itself because they are mainly focused on what the cost is to them from the rise of gas, food, and energy prices, which are essential in the daily life of an American. When these prices rise people have to pay more out of pocket and they consider this additional spending as inflation.
SOURCES:
Fixler, Dennis, and Ted Jaditz. “An examination of the difference between the CPI and the PCE deflator.”Division of Price and Index Number Research, Bureau of Labor Statistics. (1997): 47. Web. 21 Mar. 2012.
Hakkio, Craig S. “PCE and CPI Inflation Differentials: Converting Inflation Forecasts.” Federal Reserve Bank of Kansas City. (2008): 68. Web. 21 Mar. 2012.
Pettinger, Tejvan. “Economics Essays: Which Inflation Measure Should We Use?” Economics Essays. World Press, 12 Jan. 2011. Web. 22 Mar. 2012.
Pettinger, Tejvan. “Difference between CPI and PCE Inflation.” Economics Help. World Press, 11 Jan. 2011. Web. 22 Mar. 2012.
With the continual boom in technology, mixed with the ever-present economic concerns, there has been recent speculation over the efficacy of the CPI. To sum it up, people are becoming smarter consumers. Currently, the housing market is running cold compared to its 2006 counterpart. Today, consumers are much more aware of what they can handle and are thinking practically before diving into a huge investment. Similarly, consumers have been searching and successfully finding ways to cut unnecessary costs. Many Americans, including my own family, have opted out of landline phone service in recent years. My dad, like many others, took into account the fact that we really weren’t using the landline much anymore. So, we hopped off the landline bandwagon, and stayed with our AT&T cellphones (after upgrading to iPhones). The increase in smartphones and quality of cellphones are definitely offsetting the landline service as well. Finally, large discount stores such as Wal-Mart are continuing to sell products at prices much lower than competitors. With their promise of the “lowest price”, inflation doesn’t affect this chain like it does Food Lion. And the current prices are likely to continue with Wal-Mart CFO Charles Holley’s statement, “We feel like inflation will moderate.” With changes like this, it is becoming difficult to measure inflation. Since the CPI relies on the “basket approach”, how will it account for the slow demise of landlines? The substitution bias plays a small role, but people aren’t just switching from home to cell phones, they are simply eliminating the home phone basket. Also, the increase in Wal-Mart use is similar to the Costco-Sam’s Club debacle of the mid-1990s, but it also holds its own. Costco relies on selling products in bulk, and making it cheaper that way. What Wal-Mart does is sell the individual products, at a lower price than competitors. The question is, how will the CPI adapt to changes such as these?
Kowalski, Alex. “Consumer Prices in U.S. Rose in February as
Gasoline Jumped.” Bloomberg L.P. 16 Mar. 2012. Web. 22 Mar. 2012. .
“Focus on Prices and Spending | Consumer Expenditure | Volume 2, Number 12.” U.S.
Bureau of Labor Statistics. United States Department of Labor. Web. 22 Mar. 2012. .
The Personal Consumption Expenditures index and the CPI are both measures of consumer inflation. There are several reasons why we might want to use the PCE over the CPI. One reason we might want to use the PCE over the CPI is that the PCE measures expenditures from quarter to quarter while the CPI is fixed and updated every two years.(1) Another reason why we might want to use the PCE over the CPI is that the measurement of goods is broader with the PCE compared to the CPI. (2) A third reason why we might want to use the PCE over the CPI is because of the formula used to measure inflation. According to Phil Davies, a research economist for The Federal Reserve Bank of Minneapolis, “An important benefit of the PCE’s formula is that it automatically adjusts for consumer substitution among general categories of goods (such as from grapes to apples) as relative prices change.” I think that the differences between the PCE and CPI does lead to some confusion about what constitutes inflation. The reason why is because simply that there can be differences between the two measures. The way in which inflation is measured differs between the two which can result in different numbers which in turn could confuse people about why there could be different numbers for inflation and what is causing that inflation.
1. http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
2. http://www.clevelandfed.org/Research/data/US-Inflation/cpi.cfm
3. http://www.mpls.frb.org/publications_papers/pub_display.cfm?id=4793
Although the Consumer Price Index (CPI) from the Bureau of labor statistics gains more attention than the Personal Consumption Expenditures (CPE) index, it is ignorant to focus mainly on the CPI. The Federal Reserve, when it comes to inflation, refers more towards the PCE. According to Timothy Taylor, the conversable economist, that is because the PCE index is the result of a formula that is based off the changing composition of money being spent; therefore it doesn’t include some of the upward bias that goes with the fixed-weight of the CPI. These two indexes cover similar, but not exact, categories (Scope Effect) of spending and the PCE covers more than the CPI. They both also have different weights for spending, the biggest being shelter. The CPI has a larger share of spending on housing compared to the PCE because the non-shelter spending in the CES is less than the business surveys that the PCE refers to for consumption. Looking at the two indexes cause confusion about what exactly constitutes inflation because the methods for determining spending are similar but slightly different. Their numbers will not be the same so when compared together on the same graph there will be persistent differences in how they look. Although the CPI is the more widely recognized formula to use, the PCE gives us a better picture about the inflation in the economy.
Sources:
1) Taylor, Timothy. “CONVERSABLE ECONOMIST.” : Consumer Price Index vs. Personal Consumption Expenditures Index. 17 Jan. 2012. Web. 22 Mar. 2012. .
2)”U.S. Department of Commerce. Bureau of Economic Analysis.” U.S. Bureau of Economic Analysis (BEA). 1 Mar. 2012. Web. 22 Mar. 2012. .
The CPI is used to measure inflation, however if someone does not understand how this measures CPI and the factors that might lead to overstating the true inflation, then they will have misconceptions about the true rate of inflation. From year to year, the CPI measures the average prices of goods and services purchased based on the same “basket of goods.” However, sometimes, if a price of a good/service within the basket increases dramatically compared to substitute goods, then the consumer is going to buy the substitute good. Likewise, if a good in the basket does not rise compared to its substitutes, then the consumer will buy more or the “basket” good than the other. In the end, this subsitution results in showing that prices are rising more than they truly are. Another problem is that when new products are introduced, the “basket of goods” does not include that product so does not show the continuous price decrease after the first year that the new product is released. Looking at housing in the market, many people are facing unemployment which makes it harder for them to put up the amount of money needed for a house which shows housing decrease, as well as banks are finding it harder to make loans as they increase in numbers of foreclosures which will show an overall result in a decrease in housing. If we take a look at cell phones, we can see that many people are starting to turn to their cell phone as their home phone so landlines are seen to gradually decrease as cell phones are continously increasing. Cell phones are also seen to be used not just as calls but as parts of business, for alerts in schools, etc. which is increasing their demand and the money that Americans are spending on them today. Overall, without a clear understanding of what causes prices to increase and decrease, consumers have misunderstandings on inflation and think inflation is about 1% higher than what it actually is making it hard to measure true inflation just from the CPI.
Consumer Price Index is used to measure the prices of goods over time. The CPI measures this by taking the average of prices of goods and services that were purchased by an average household. Most commonly this index is used to help measure inflation within goods. While measuring inflation with the CPI it is mostly inaccurate due to many different biases, that make the inflation overstated,one being the substitution bias. Also the CPI uses a “market basket” approach. Within this approach inflationn is overstated because it does not take in to account the change in products the consumer buys each year. Since at most time the CPI is inaccurate, people turn to a more accurate measure known as the Personal Consumption Expenditure (PCE). PCE, unlike CPI takes into account the changes in products each year, preventing inflation from being to high. The PCE also includes more goods and services in their measure, not only those specified to a household. A disadvantage of the PCE is the failure to calculate both food and energy prices. People not aware of this may be taking into account an inaccurate inflation rate, causing confusion for those trying to find an accurate measure.
Source-
An Examination of the Difference Between the PCE Deflator and the CPI
http://www.bls.gov/osmr/pdf/ec020100.pdf
There are two types of indexes used by the Fed to measure inflation. One of which is the Consumer Price Index (CPI) and the other is the Personal Consumption Expenditures (PCE). The CPI is probably more commonly know to individuals rather than the PCE; however the PCE seems to be the more accurate measure of inflation. One main difference between these two indexes is how they are calculated. The CPI is calculated using the Laspeyres formula, which makes the CPI a fixed-weight price index. In contrast, PCE is calculated by using the Fisher-ideal formula. The PCE is constantly being updated whereas the CPI is adjusted every two years. Another reason why the PCE is better is because consists of a broader measure of goods and services compared to the CPI which is based only on household expenditures of the average family size.
Sources:
http://www.clevelandfed.org/research/trends/2010/1110/01infpri.cfm
Pettinger, Tejvan. “Difference between CPI and PCE Inflation.” Economics Help. 11 Jan. 2011. Web. 22 Mar. 2012.
http://www.economicshelp.org/blog/2583/inflation/difference-between-cpi-and-pce-inflation/
In our economy we use either the Consumer Price Index (CPI) or the Personal Consumption Expenditures (PCE) to measure inflation. The CPI is the average of the prices of the goods and services purchased by a typical family of four, while the PCE is a measure of price changes in consumer goods and services. However there is usually a problem that occurs with using the CPI and that is that it over-exaggerates the rate of inflation due to several biases. The biases that cause this overstates the rate of inflation are substitution bias, increase in quality bias, new product bias, and outlet bias. As a result, many feel that the PCE is more accurate and efficient then the CPI. Along with this the CPI has a fixed “basket of goods” that are used to measure the price index, while the CPE allows for change in the goods and services used each year. Other advantages that the PCE can be argued as better then the CPI is that it includes many more goods then the CPI and also include “price expenditures made by households, including those made on behalf of households” (Moyer, 2). The last advantage that the PCE has over the CPI is that the “weights are derived from business surveys” rather then households, which may result in inaccuracy (Prabhat, 1). These things can ultimately lead to confusion in what exactly is inflation. Many people don’t realize that the real inflation rate also includes expenses that aren’t just out-of-pocket such as energy costs; the CPI doesn’t include these extra expenditures.
Sources:
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-pce/
The Consumer Expenditure Survey, while certainly a good tool for measuring consumption on a general level, would seem to be less useful in examining trends due to the lack of substitution. It would appear that less people are spending on housing due to several factors, all results of the housing market collapse – new homebuyers are undoubtedly getting lower priced homes with better mortgage deals. Additionally, the pool of homebuyers decreased by roughly 700,000 people, signifying that many people may have been forced into foreclosure (or are in the process of foreclosing and make reduced payments or none at all), sold their home for a loss, or have refinanced. While the average household income fell, the proportional drop in household spending could not simply be accounted for by the loss in average income, as this is an aggregate of the entire population survey. Job losses and pay cuts would explain the decreased average income, while the housing crisis would seem to be a primary factor in the decrease in housing spending.
In regards to the issue of cell phone vs. landline phone spending, it is apparent that with the rise of cell phones, data plans and increasingly more useful cell phones have resulted in additional fees and expenses, making the cell phone more valuable and the landline phone less so. It would seem that in the wake of the cell phone as a substitute for landline phones, many households consider a landline phone to be an unnecessary expense, and thus cut their service accordingly. Many consumers might reason that if you can take your phone anywhere and use it essentially as a handheld computer, why spend money on a landline phone (which has in recent years become little more than a telemarketing service)? As the book notes, the substitution bias is one reason the CPI is less reliable than it could be. Many of the other changes in consumption might be explained by other biases, such as the outlet bias- the increased use of discount stores in the wake of the recession has been noted in the news in recent years.
The Personal Consumption Expenditures (PCE) index should be preferred over the Consumer Price Index (CPI) for three main reasons. First, the PCE accounts for not only expenditures made by households but also the expenditures made on behalf of households. This can include services and goods used to help benefit households purchased by companies or firms. Medical care is an example of one of these expenditures to benefit households which is seen on the PCE and holds more weight than on the CPI. The second reason is the PCE is updated quarterly while the CPI is updated every two years. This gives a more up to date representation of the current expenditures that household are currently spending their money on. The final reason the PCE should be used over the CPI is the weights in the PCE are deprived from business surveys and not household surveys. Business surveys allow a more accurate depiction of the goods and services being purchased by households. Household surveys can be unreliable and you don’t always reach an accurate representation of the target group. Using these three reasons, the PCE simply gives a more realistic and accurate portrayal of the expenditures currently being purchased by the households today.
“Comparing Price Measures — The CPI and the PCE Price Index”, by Brian C. Moyer of the National Association of Business Economics Policy Conference, 3/13/2012.
The Consumer Price Index provides a statistical approximation of the price changes that occur in a “basket” of goods and services. The CPI includes the prices of food, housing, clothing, gas, transportation, doctor/dentist fees, medications, and other goods and services that people buy for day-to-day living. As the prices of these goods and services included in the “basket” rise and fall, it makes it difficult to measure inflation on aggregate. If one factor (housing) decreases while another (cellphones) increases, then the inflation calculation will be skewed in a misleading way. According to the Bureau of Labor and Statistics, housing is the largest single item in the CPI calculation and makes up about 41% of the CPI calculation. The BLS also states that “within the housing category, most of the relative importance belongs to the index for ‘owners’ equivalent rent’ and that for ‘residential rent,’ for which data are obtained through the Housing survey. These two items represent 20 percent and 6 percent, respectively, of the total CPI. The remaining 15 percent accounted for by the ‘housing’ group consists of many indexes, which are handled through the Commodities and Services survey.”
According to the BLS, consumer spending on housing has been on the decline for the past few years. In the Consumer Expenditure Survey of December 2011, it was reported that mortgage interest and charges have been dropping since the year 2007 and are reporting levels that are 13.1% lower than in 2007. The reasons for a decline in housing prices could include mortgage delinquencies (many houses for sale), tighter lending standards (less people can qualify to get a mortgage), legal problems of entire industry (foreclosure problems), underlying economy (high unemployment and wages not rising, no confidence to make large commitments). As unemployment levels rise and consumer confidence falls, people are less willing to take loans from banks. This creates a lower demand in the housing market while the high foreclosure rates lead to excess supply of houses. It all has to do with supply and demand. When there is too much of a product available, prices decline. The housing industry is experiencing deflation. All of the above factors contribute to low prices. People are less willing to spend money on housing and are heading more in the direction of renting. This also may lead to some of the misunderstanding of what is reported as inflation because the aggregate equation could make people think that housing, for example, is inflating when in fact the prices are “deflating.” Also, in the next coming years, it will be the time when many of the baby boomers retire. These retirees will seek homes that are inexpensive and good for a final move. This is an example of people changing their behavior—the older people get, the more likely it is that they own their home and have paid off their mortgages.
Technological advances have also influenced the spending habits of many Americans. For example, according to the Bureau of Labor Statistics, the amount Americans spend on cellular phone services has increased from $210 in 2001 to $760 in 2010, however, the amount spent on landline phone services has decreased from $686 in 2001 to $401 in 2010. Technology has provided increased usefulness and quality of life which is not apparent in a fixed “basket” of goods and services. As technology advances, many old forms of technology become outdated and people no longer have a need for them. This makes the price of some things go up faster (cellular phones) and forces other prices down (landlines). Some people have chosen to have only cellphones while others have chosen to have either both or neither.
Barry, Dan. “Boomers Hit New Self-Absorption Milestone: Age 65.” New York Times. (2011): n. page. Web. 21 Mar. 2012. .
“The Economic Collapse Are You Prepared For The Coming Economic Collapse And The Next Great Depression?.” House Prices – Up Or Down In 2011?. Powered by WordPress & the Atahualpa , 2012. Web. 21 Mar. 2012. .
United States. Bureau of Labor Statistics United States Department of Labor. Consumer Price Index. Washington, DC: , 2012. Web. .
United States. Bureau of Labor Statistics. Focus on Prices and Spending. Washington, DC: Division of Information and Marketing Services, 2011. Web. .
United States. Bureau of Labor Statistics. Revision of the CPI housing sample and estimators. Washington, DC: , 2001. Web. .
When people see fluctuating gas prices, they often confuse this with overall inflation. This is because these price fluctuations are often very dramatic and constitute a major portion of your average American’s budget. As a result, the CPI is often a very skewed indicator of the economy and inflation. Taking out the “volatile” categories of food prices and energy prices leaves us with a better indicator of the economy – the core CPI.
According to Marketwatch, the CPI jumped 0.4% which “stemmed mostly from the 6.0% spike in the price of gasoline – the biggest jump since December 2010.” This rise in gas prices accounted for the majority of the rises in consumer prices. However, according to the same Marketwatch article, once energy is taken out of the equation, the core rate of inflation (as measured by the core CPI) rose only by a smaller 0.1%. In other significant price news, the price for clothing dropped by 0.9%, which is the “biggest decline is six years.” Although this is good news for consumers, the price decline hurts producers. Producers don’t complain about prices as nearly as much as consumers. Neither are consumers overly appreciative of price declines. With a (slight) decrease in the price of clothing, people will probably shift their purchases to take advantage of this. However, given the increase in auto prices (which is a sign that the economy is getting better), although gas prices hurt overall consumption (that is, with higher gas prices, people buy less of other things as they allocate more money to gas), the decrease in the price of clothing and increased demand for cars should somewhat balance out the price changes in gas.
Source:
http://www.marketwatch.com/story/consumer-prices-rise-sharply-in-february-2012-03-16
The Consumer Price Index provides a statistical approximation of the price changes that occur in a “basket” of goods and services. The CPI includes the prices of food, housing, clothing, gas, transportation, doctor/dentist fees, medications, and other goods and services that people buy for day-to-day living. As the prices of these goods and services included in the “basket” rise and fall, it makes it difficult to measure inflation on aggregate. If one factor (housing) decreases while another (cellphones) increases, then the inflation calculation will be skewed in a misleading way. According to the Bureau of Labor and Statistics, housing is the largest single item in the CPI calculation and makes up about 41% of the CPI calculation. The BLS also states that “within the housing category, most of the relative importance belongs to the index for ‘owners’ equivalent rent’ and that for ‘residential rent,’ for which data are obtained through the Housing survey. These two items represent 20 percent and 6 percent, respectively, of the total CPI. The remaining 15 percent accounted for by the ‘housing’ group consists of many indexes, which are handled through the Commodities and Services survey.”
According to the BLS, consumer spending on housing has been on the decline for the past few years. In the Consumer Expenditure Survey of December 2011, it was reported that mortgage interest and charges have been dropping since the year 2007 and are reporting levels that are 13.1% lower than in 2007. The reasons for a decline in housing prices could include mortgage delinquencies (many houses for sale), tighter lending standards (less people can qualify to get a mortgage), legal problems of entire industry (foreclosure problems), underlying economy (high unemployment and wages not rising, no confidence to make large commitments). As unemployment levels rise and consumer confidence falls, people are less willing to take loans from banks. This creates a lower demand in the housing market while the high foreclosure rates lead to excess supply of houses. It all has to do with supply and demand. When there is too much of a product available, prices decline. The housing industry is experiencing deflation. All of the above factors contribute to low prices. People are less willing to spend money on housing and are heading more in the direction of renting. This also may lead to some of the misunderstanding of what is reported as inflation because the aggregate equation could make people think that housing, for example, is inflating when in fact the prices are “deflating.” Also, in the next coming years, it will be the time when many of the baby boomers retire. These retirees will seek homes that are inexpensive and good for a final move. This is an example of people changing their behavior—the older people get, the more likely it is that they own their home and have paid off their mortgages.
Technological advances have also influenced the spending habits of many Americans. For example, according to the Bureau of Labor Statistics, the amount Americans spend on cellular phone services has increased from $210 in 2001 to $760 in 2010, however, the amount spent on landline phone services has decreased from $686 in 2001 to $401 in 2010. Technology has provided increased usefulness and quality of life which is not apparent in a fixed “basket” of goods and services. As technology advances, many old forms of technology become outdated and people no longer have a need for them. This makes the price of some things go up faster (cellular phones) and forces other prices down (landlines). Some people have chosen to have only cellphones while others have chosen to have either both or neither.
Barry, Dan. “Boomers Hit New Self-Absorption Milestone: Age 65.” New York Times. (2011): n. page. Web. 21 Mar. 2012. .
“The Economic Collapse Are You Prepared For The Coming Economic Collapse And The Next Great Depression?.” House Prices – Up Or Down In 2011?. Powered by WordPress & the Atahualpa , 2012. Web. 21 Mar. 2012. .
United States. Bureau of Labor Statistics United States Department of Labor. Consumer Price Index. Washington, DC: , 2012. Web. .
United States. Bureau of Labor Statistics. Focus on Prices and Spending. Washington, DC: Division of Information and Marketing Services, 2011. Web. .
United States. Bureau of Labor Statistics. Revision of the CPI housing sample and estimators. Washington, DC: , 2001. Web. .
The Personal Consumption Expenditures (PCE) and the Consumer Price Index (CPI) are two different ways to measure inflation in the economy. The CPI is the most commonly used measure of inflation but is flawed by overstating the true underlying rate of inflation. “This happens because consumers alter the mix of products they buy each year, which affects the market-basket approach and cause the CPI to overstate the actual inflation.” (pg.476) The PCE has certain advantages over the CPI that makes it more preferable to use. The PCE is a broader measure of inflation, which includes the prices of more goods and services than the CPI. The PCE is considered a “chain-type price index” which allows the mix of products to change each year. The PCE also allows the Fed to track the historical trends in the inflation rate in a more efficient manor by recalculating the past values of the PCE as new data becomes available. The differences between these two price indexes can possibly lead to confusion as to what constitutes inflation. This happens because the CPI only measures the “out-of-pocket expenses” while the PCE includes inflation on all expenses resulting in a higher PCE inflation rate. The “core PCE” can cause another reason for confusion. The core PCE excludes food and energy prices. “Food and energy prices continuously fluctuate which cannot easily be controlled by monetary policy.” (pg.476) If a price index includes food and energy prices than it may not give a clear illustration of the trends in inflation.
Sources:
Hubbard, R. Glenn., and Anthony Patrick. O’Brien. Macroconomics. 3rd ed. Upper Saddle River, NJ: Pearson Prentice Hall, 2010. Print.
What’s Up with the Gap between the Core PCE and the Core CPI
By Brent Meyer
http://www.clevelandfed.org/research/trends/2010/1110/01infpri.cfm
The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) are both ways to measure the rate of inflation. However they have many differences such as their growth rates, seasonal adjustment differences, and price differences. The growing interest rates seen in the CPI are much greater than those of the PCE. The CPI uses a different index number formula then the PCE, which cause them to have different results over time. The CPI uses the Lasperes index and the PCE uses the Fisher- Idea formula, which is more flexible and allows for substitution. The CPI uses the weights that are fixed and do not change over time which. The CPI sometimes overstates inflation compared to the PCE. Another factor that causes a difference is that the CPI measures the out-of-pocket expenditures of each household whereas the PCE measures the goods and services purchased by the households this is referred to as the scope effect. I think that this is confusing to people because of the different formulas and the different scopes that are accepted for each index. The PCE is more accurate for measuring inflation because it measures the trends in each quarter.
The CPI is a standard measurement for inflation, however it leaves some important factors out when choosing what to put in the ‘basket of goods’ that gets evaluated. While no measurement of inflation can ever be fully accurate, the CPE (Personal Consumption Expenditure Price Index) does in some ways prove to be more beneficial for economic analysts. The PCE price index, which is produced by the Bureau of Economic Analysis (BEA), “measures the prices of goods and services purchased by persons, individuals, and nonprofit institutions in the National Income and Product Accounts” meaning personal consumption expenditures. This is different from the CPI because it is focusing on more than just the out-of-household spending. When comparing the 2, the CPI is a narrow depiction of what households consume. CPE includes employers and non-profit organizations, who non-profit or not are all consuming goods and services and effecting the economy. Both of these measurements will over time reflect upon each other because of the overall actions of consumers, but CPI tends to a few percentages higher at the time of observation. It has also stood out that CPI measures the trends of consumers and their effects on inflation after a longer period of time. The CPE on the other hand measures the changes in trends much more frequently (quarterly). Both of these measurements of inflation could be looked at after a year and give a similar conclusion on the ‘bucket of goods’ (plus other factors) that contributes to inflation. I think that overall, using the PCE and considering food and energy prices could aid analysts when measuring the rate of inflation. It seems to be more beneficial if we considered all of the consumer effects on the economy not just the household purchases in a spread time period.
Sources:
http://www.kansascityfed.org/Publicat/Econrev/PDF/1q08Hakkio.pdf
The CPI, or consumer price index, measures the changes in price of certain goods and services bought by households. It is measured using a fixed basket, meaning each time it is the same goods or services compared to one another.
The PCE, or personal consumption index, also measures the change in the price of certain goods and services. Unlike the CPI, however, the PCE uses a broader group of households (collecting data from not only urban households (like the CPI) but rural ones as well), and a broader group of goods. In the CPI, the basket used is fixed, with the services and goods measured not being changed. The PCE on the other hand, accounts for changes in consumer interests. It also derived using a different formula to the CPI (chained Fischer index formula versus Laspeyres-type formula) which some say is more effective, as it is takes the average of two fixed-weight measures of price change instead of just one.
The PCE also places more weight on medical care than the CPI does as it accounts for medical care paid for by employers, households, and government programs versus just the consumer. It also places considerably less weight on housing and shelter than the CPI does. The fact that these two price indexes place different weights on different goods can be extremely confusing when it comes to what constitutes inflation. It leads to the two price indexes ending up with completely different results, something which is extremely confusing for the average consumer. When faced with two completely different results, one can never be sure of which is actually correct. Their dollar can potentially be worth more in one price index than the other. Also, the PCE’s ever changing basket can be confusing as people will not know exactly what is being measured.
Source:
http://www.mpls.frb.org/publications_papers/pub_display.cfm?id=4793
Preferring PCE index over the CPI index would be supported by the fact that PCE measures the change in prices of consumer services and goods. The CPI on the other hand measures a basket of goods prices that an average household would purchase. WIth the PCE there is more useful information that can come of it because it also takes medical care and extra expenditures into account. Another reason why one would prefer PCE over CPI is that the PCE is updated quarterly where the CPI is updated every two years. How the different indexes are measured also comes into account where the CPI is measured with the Laspeyres formula meaning it is on a fixed weighted price. Where as the PCE is measured on the Fisher-Ideal formula. When a person wants to look at inflation and it affect on his/her everyday goods and services the PCE will give more information that is relevant because of the extra add on ons it take into account. Both indexes give useful information to help determine inflation of different products but PCE offers more range of products that are taken into account so that is why one would prefer to use this index over CPI.
The Consumer Price Index, which measures the weighted average of prices of a basket of consumer goods and services, rose 0.4% in the last month, which is the largest bump in the last 10 months. This number may seem high and points to inflation and rising consumer costs, but this CPI rise is misleading. Most of the increase can be attributed to the volatile aspects of the CPI, energy and food. This gives us the core CPI, which only rose 0.1%, a much less drastic rise. The price of food remained generally the same in February which leaves us with energy as the reason for the large jump in CPI. Gas prices rose 6.0% which was mostly to be expected according to Stephen Stanley, the chief economist at Pierpont Securities, who stated “The February CPI was relatively benign, outside of the as-expected surge in gasoline prices.” Many economists, including The Federal Reserve also believes that the core CPI is a better tool for gauging inflation due to the tendencies of energy and food to fluctuate heavily at times. The CPI can also be misleading in calculating inflation because it does not take into account substitutes in the basket when prices change, unlike the Personal Consumption Expenditures which is updated quarterly and considers expenditures considered on behalf of a household. Therefore the CPI, due to its inclusion of volatile products and lack of updating, can be a misleading tool used when looking at inflation.
Forgot to include my sources:
http://www.marketwatch.com/story/consumer-prices-rise-sharply-in-february-2012-03-16
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
http://www.bls.gov/news.release/cpi.nr0.htm
After reading the class responses to the third question posed about the differing use of the CPI and PCE calculations, further questions developed around interesting points made by my peers. As previously pointed out the PCE method proves more precious due to the quarterly calculations and revision to current consumer preference. Research has provided a lack of reasoning behind why the nation continues to use the CPI process. No standard for calculating and comparing inflation exist as observed through a lack of standardization between countries of similar stature to the United States. Understandably consumer trends within regions exist but given our current reliance on international trade as seen through the increase in costs on goods such as oil, one might expect a trend toward standardization given our current alliance on foreign funding. During the process of researching inflation methods many economists identify different stages in the U.S. such as following WWII, after 9/11 or after the housing crisis for 2008. Some might argue that the use of CPI remains as a comparison to previous years in American history. To this I question if these comparisons become obsolete given that the dynamics of trading has changed drastically with the increase in technology and the rise and dependence on super powers such as China who have entered the market.
While reviewing the provided link to the BLS’ recent CPI report, I began searching for prices that had high increases in their index values, and the first culprit was gasoline, everyone’s favorite, which had risen by 5.08% between November 2011 and February 2012. Another one caught my eye though, and although the percent change in its index wasn’t as high as gasoline, I think the rise in tuition costs is probably a key factor in perceived monetary value for students and their families.
Strangely enough, the BLS’ CPI report gave tuition costs a 607.338 and 612.808 index in November and February respectively, which suggests a measly inflation of 0.9%. This is definitely not the case, however; articles on Reuters and NPR both point out that tuition has been steadily climbing, thanks in part to universities not growing in efficiency and also in part to decreases in government subsidies. Given the impact these tuition prices have on the wallets of students and their families, the sky-high prices likely give most people the impression that their dollar is worth a great deal less thanks to inflation, but BLS’ report seems to indicate that university tuition prices are a special case and don’t directly influence “real” inflation as much as these families may think.
Sources:
Abramson, L. (2011, October 19). Why is college so expensive? Retrieved from http://www.npr.org/2011/10/19/141505658/why-is-college-so-expensive
BLS. (2012, March 16). Consumer price index for all urban consumers (CPI-U): Seasonally adjusted U.S. city average, by expenditure category and commodity and service group. Retrieved from: http://www.bls.gov/news.release/cpi.t02.htm
Salmon, F. (2011, November 21). Why tuition costs are rising. Retrieved from http://blogs.reuters.com/felix-salmon/2011/11/21/why-tuition-costs-are-rising/
While the CPI observes the purchases of goods and services by the average individual, the PCE index measures the purchasing power of the average household while also including non-profit expenditures. CPI does not observe such non-profit activities. Thus, one could say that the PCE offers a more accurate representation of the state of the economy since it observes not only business transactions but also non-profit expenditures. Also, since couples tend to make substantially different incomes, the PCE offers a better representation of the purchasing power of a family as a collective unit rather than observing each family member for their own purchasing power. Since the PCE measures each household collectively and includes non-profit expenditures, it may offer more realistic measures of inflation than the slightly lesser inflation measure offered by the CPI.
http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-pce/
The average person often views CPI as a clear indicator of inflation. In order to calculate the percent of inflation or deflation we have to use the Consumer Price Index as a starting point. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Because the true rate of inflation cannot be observed, we can use the CPI to help us approximate the true inflation rate. Inflation’s effects on an economy are various and can be simultaneously positive and negative. When the consumer decides one product is worth more to them personally than another product, that product creates a bigger demand. Such as in the case of the demand for clothes vs. gas prices. Along with the increase of uses for gas, the need for clothing decreases. With a large drop in the availability of gas, prices rise, this causes inflation to raise. Those that have trouble affording gas, as well as other circumstances, attempt to decrease their spending on clothing. There are many factors that go into inflation; therefore, I believe that the CPI is not a clear representation of actual inflation.
Sources:
http://econpage.com/202/handouts/CPI-handout.html
http://www.bls.gov/cpi/cpifaq.htm#Question_1
http://inflationdata.com/articles/2008/08/18/inflation-vs-consumer-price-index-do-you-know-the-difference/
After referring to a report by the Bureau of Economic Analysis, we can see the two different ways that the inflation rate can be measured. These two ways are called the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE). In my mind, the PCE is a better way to evaluate the inflation rate because the weights that go into the PCE are derived from businesses rather than from households, where the CPI derives its weights. Businesses show more accurately, the goods being purchased by households within the United States. With weights from households, the data collected can sometimes be inaccurate because of certain survey bias. This information can also lead to a result that manufactures the inflation rate for a single area rather than then the entire country. In my mind this reason alone is large enough for the Fed to change its technique for measuring the inflation rate.
Source:
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
The national government collects data about what we as nation are buying, how much of it we’re buying, and how much we are spending on these goods. This information is collected and separated for different sectors of our total expenditures, such as corporate and business, government, household and personal, and all foreign transactions. The PCE or Personal Consumption Expenditures measures goods and services purchased by the personal sector. The CPI, Consumer Price Index, also focuses on the personal sector, but it measures the change in prices of goods and services in a particular market basket of goods. Both the CPI and PCE look at individual consumers in the U.S. but PCE covers a much broader spectrum of people. The PCE, unlike the CPI, also includes the purchases of goods and services of nonprofit institutions, military personnel, and U.S. residents abroad. Besides the fact the PCE includes more people in their surveys, they also include more transactions, regardless of how they were made, for example if housing rented or owned. A large problem with the CPI is that it’s based on a generalizing national index, where the PCE can explain a more personal consumer’s experience. As far as these indexes explaining inflation, it’s hard to say which is better. Inflation is a “process of continuously rising or falling value of money” and should be looked at differently based on the intended purpose of the data. The CPI and PCE have such different results about rising prices, that depending on what you want to do with the results, you can more accurately understand inflation based on your goal.
Sources:
1). Personal Consumption Expenditures, Methodology Papers: U.S. National Income and Product Accounts, U.S. Department of Commerce
http://www.bea.gov/scb/pdf/national/nipa/methpap/methpap6.pdf
2). Consumer Price Index, Bureau of Labor Statistics, United States Department of Labor
http://www.bls.gov/cpi/cpifaq.htm#Question_1
The housing crisis a few years ago is very interesting. From my understanding restrictions were too lose and people were buying houses they couldn’t afford. When they couldn’t keep up with the mortgage the house go re-possessed. So now people are A) more cautious about buying houses that might be out of their price range or close to it and B) there are so many foreclosures as well as people trying to sell their house because it is too expensive and thus driving the price of housing down.
The CPI (Consumer Price Index) and the PCE (Personal Consumption Expenditures) are two different ways to measure inflation in our economy. They both are a little different though. The differences can be summed up into four effects. The first effect is the Formula Effect. The CPI is based on a Laspeyres formula. The PCE is based on a Fischer-Ideal formula. A Fischer-Ideal formula is considered a “superlative” index. This means that it reflects consumer substitution among detailed items as relative prices change. These kind of indexes are hard to keep in real time because they require expenditure data for the current period, which is not available. The next effect would be the Weight Effect. The weights assigned to both the CPI and the PCE differ. The CPI are primarily based on the Consumer Expenditure Survey, which is a household survey conducted for the BLS by the Census Bureau. The PCE’s relative weights are derived from business surveys. The third effect would be the Scope Effect. Some of the items and expenditures in the PCE are outside the scope of the CPI. For example, the medical expenditure weights for medical care services in the CPI are derived only from out-of-pocket expenses paid for by customers. However, medical care services in the PCE index include those services purchased out of pocket by consumers and those paid services purchased on behalf of the consumer. So, health insurance paid for by employers, as well as services paid for by government programs, such as Medicare and Medicaid, would be counted in the PCE, but not the CPI. Finally, the last effect is just a variety of remaining differences that don’t fall under one specific category. These differences are things such as how they are adjusted at different rates. The PCE is adjusted at a quarter to quarter rate, whereas the CPI is adjusted every two years. Another difference is the prices. The PCE is produced by BEA using the BLS prices, as well as other data sources. The CPI is produced by the BLS using surveys of consumer prices, and some other data sources.
Sources:
Comparing Price Measures- The CPI and the PCE Price Index by Brian C. Moyer
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
Focus on Prices and Spending by U.S. Bureau of Labor Statistics May 2011 Volume 2, Number 3
http://www.bls.gov/opub/focus/volume2_number3/cpi_2_3.pdf
The Consumer Price Index is a measure of the changes in the purchasing power of an average family. The CPI inflation rate is found by comparing the CPI of a current month to the CPI of the corresponding month during the previous year, also known as “the basket of goods”. I feel like this could lead to confusion if people are not educated on how the CPI works and how the inflation rate is determined. Also the CPI is flawed in that it does not update its “basket of goods” often and has the substitution bias which can lead to misconceptions of the actual inflation rate. The Personal Consumption Expenditures is the measure of the changes in price of consumer services and goods. It is aimed mainly at individuals and is constantly being adjusted from quarter to quarter. Also, the PCE is based on business surveys rather than household surveys like the CPI. The business surveys are more accurate than the household surveys thus giving the PCE another advantage. Lastly, the PCE uses the Fisher-Ideal formula which takes into account substitution and therefore can be more accurate in predicting inflation, unlike the CPI which uses Laspeyres formula which does not. Overall, These two different ways of calculating inflation can get confusing at times, but I feel as though the PCE is a more reputable and accurate indicator of inflation even though the CPI has been more popular in the past.
Sources:
http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-pce/
The Fed uses a different means of measure in order to discuss inflation in the economy. Although Consumer Price Index (CPI) is typically used, the Bureau of Economic Analysis (BEA) uses Personal Consumption Expenditures (PCE) to account for inflation instead. This PCE method, however, may actually be a more reliable measure of inflation that should be consistently used by everyone. First, the PCE and CPI differ as the CPI is based on how much consumers spend out-of-pocket in urban homes. Meanwhile, PCE includes all expenditures by and for any given household. With this, the PCE takes more households and expenditures into account, rather than merely selecting households in a given area. While the CPI is based on the Laspeyres formula, the PCE uses the Fisher-Ideal formula. This is more reliable since it takes substitutes into account, which the CPI does not. This has a downfall as well however, since the data cannot be retrieved as frequently as needed to be as current as possible. The CPI and PCE also weigh goods and services differently as well. The CPI derives their weights on data from urban household surveys. In comparison, the weights for the PCE are derived from business surveys in which the business reports its retail data to the Bureau. An important aspect to note about PCE is its inclusion of health insurance into its measure. These expenses are not paid out-of-pocket and, therefore, are not included in the CPI. With this, the PCE also takes more goods and services into account when determining inflation, which is important. The PCE is also more desirable considering its expenditures are updated quarterly rather than every two years in calculating the CPI. With this, the PCE expenditures are more accurate considering they are observed more frequently. It’s clear that these differing methods will create confusion about what constitutes inflation. Both methods include different goods and services, considering the PCE includes health insurance from employers, and they both have varying weights because the PCE surveys businesses while the CPI surveys the consumer households. Without considering substitution, the CPI assumes families will continue to buy the same good over a two year period, even if the price increases and they could buy something else for less money instead. This creates a substitution bias in the inflation measure and makes what accounts for inflation confusing, considering we mostly rely on the CPI which is biased in this aspect. Since these measures both vary in their means of measuring inflation, it’s hard to determine what constitutes inflation when the Fed uses a more inclusive measure that’s updated more frequently while everyone else uses the CPI when they each account for different aspects in their inflation calculations.
Sources:
1. Comparing Price Measures — The CPI and the PCE Price Measures
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf
2. Focus on Prices and Spending
http://www.differencebetween.net/business/finance-business-2/difference-between-cpi-and-pce/
3. Difference Between CPI and PCE
http://www.bls.gov/opub/focus/volume2_number3/cpi_2_3.pdf
In response to the second question:
Inflation usually effects buying power (http://useconomy.about.com/od/inflationfaq/f/infl_impact.htm), which would be a reasonable explanation for the decline in spending among the given categories (transportation, apparel, housing, etc.). One glaring detail to notice, however, is the decline in overall income, which would also lead to less spending, probably more directly than does inflation.
Inflation may affect things differently. For example, gas prices may soar while the price of houses drops. Inflation also causes a subtle drop in the standard of living. People may switch from BMW’s to Honda’s. Although inflation has affected both car types, however consumer spending has declined with the purchase of the cheaper automobile.
All statistics shown on the given link point to decreased spending. Would I be too off base to inquire if this decrease in spending was related to things other than inflation? Just because people are substituting items in the same basket, that does not necessarily mean inflation is the primary cause. Technology changes (i.e. cell phone vs land lines) may be more efficient, causing people to change. My primary point is inflation may not be the primary issue in terms of spending.
In response to J. Wang’s post, gas prices alone will not indicate the level of inflation; neither will house prices alone, phone prices alone, transportation costs alone, etc. Contrasting each variable against the next will be of help, as will looking at the reasons for the price increase.
http://www.shadowstats.com/article/consumer_price_index
http://useconomy.about.com/od/inflationfaq/f/infl_impact.htm
According to Consumer Spending in 2010 by the Bureau of Labor Statistics, the average annual expenditures per consumer unit (CU) for housing had been dropping since 2007. The data is based on the Consumer Expenditure Survey. The report says the decline in housing market, lower mortgage interest rate, and increasing foreclosure rate cause this drop in the CU of housing. Because of the inflation in housing market before the latest economic crisis was constantly rising, consumers would borrow money from banks and buy houses as an investment. As a result, housing bubble inflated but burst in 2008, causing homeowners had negative assets because the house was not as valuable as the mortgages. Although the housing price dropped since 2008, the price is still high today compare to before-inflation period. However, the income of the people did not inflate as much as housing price’s inflation. Therefore, the decline in housing market still exists.
People are shifting from land-line phones to cellular phones because of the advancement in technology. It is hard to say how this shift can relate to inflation.
Source:
http://www.bls.gov/opub/focus/volume2_number12/cex_2_12.htm
The PCE (Personal Consumption Expenditures) index differs from the CPI (Consumer Price Index) in a few ways. Firstly, the CPI uses surveys of consumers rather than using prices indexes as the PCE does. The CPI also accounts for spending through out of pocket expenditures by customers rather than expenditures made by households and on behalf of households as the PCE does. The CPI is on a quarterly basis while the PCE’s market basket remains fixed and only changes every two or so years. The CPI is stronger in some aspects while the PCE is stronger in others. For example, the CPI is stronger than the PCE is its constantly changing market basket (on a quarterly basis). The PCE fails to acknowledge that new products can enter a market and have a significant affect on the market in a very short period of time, which harms the accuracy of the PCE. The PCE is a stronger measurement than the CPI in some aspects as well. For example, the PCE uses price indexes for its measurements while the CPI uses surveys. The reason that this could be inaccurate is because only a certain demographic of people take the time out of their day to take surveys, and the methods in which the Bureau of Labor and Statistics sends out their surveys is also odd because they send it to various households and ask them to fill them out. Although no one system is exactly better than the other, it is important for consumers to understand the difference between the two in order to not have misconceptions about the rate of inflation set out by the FED versus other government organizations such as the Bureau of Labor Statistics. It would make it much easier on consumers if there was a standardized measurement of consumption in the United States, since many do not even try to understand the simplest aspects of the economy in the first place.
Sources:
1. Comparing Price Measures — The CPI and the PCE Price Measures
http://www.bls.gov/respondents/cex/
2.. Recent CPI Survey Results
http://www.bls.gov/news.release/cesan.nr0.htm
3. Comparison Between PCE and CPI
http://www.bea.gov/papers/pdf/Moyer_NABE.pdf