The Inflation Rate You Should Be Following

The inflation rate most widely followed is the consumer price index, but the personal consumption expenditures index is what you should be following.

Feb 26, 2014 at 1:03PM

Every month the media fawns over the consumer price index. But the personal consumption expenditures, or PCE, inflation rate is what you should be paying attention to. It's the measure the Federal Reserve follows for economic policy, and it's updated to reflect consumer spending more frequently than the consumer price index, making it a better measure of real-time inflation.

What is inflation?
Inflation is the rate of increase in the prices of goods and services, and it's reported as a percentage change. As prices increase, the "purchasing power" of your money decreases -- i.e., your money is able to purchase less. While the PCE inflation rate is reported monthly, economists generally look at the change over 12-month periods, as the month-to-month data can be noisy.

As an example, if the inflation rate were 2%, then you would need 2% more money than you did a year ago to buy the same basket of goods and services. The personal consumption expenditures inflation rate is just one method to track the inflation rate; others include the consumer price index and the core inflation rate.

Personal consumption expenditures inflation rate
The personal consumption expenditures inflation rate is reported each month by the Bureau of Economic Analysis as part of the Personal Income and Outlays report; a full schedule of future release dates can be found here. The PCE is meant to be one of the most accurate measures of inflation, because it updates the goods and services that it measures monthly. The Federal Reserve generally targets annual inflation of 2%. Lately, though, inflation has been running well below the Fed's target.

US PCE Inflation Rate Chart

U.S. PCE Inflation Rate data by YCharts.

Inflation is dangerous, as it eats away at investors' hard-earned savings; each year, your dollar is worth less as prices rise. While inflation hasn't been much of an issue the past few years, older U.S. investors still remember the damaging effects of inflation when it was much higher.

US PCE Inflation Rate Chart

US PCE Inflation Rate data by YCharts.

Difference from CPI
There are three main differences between PCE inflation rate and CPI inflation rate. For three main reasons, PCE inflation rate is seen as a more accurate way to measure the inflation that households face:

  1. The formulas used to calculate inflation are different in each case. The big point is that the weights in the PCE change as people substitute away from some goods and services toward others on a month-to-month basis, while the CPI basket is fixed for two years, which can lead to an upward bias for the CPI.
  2. To get monthly data on changes in purchases, the PCE uses the data from multiple business surveys, including the Census Bureau's annual and monthly retail trade surveys, the Service Annual Survey, and the Quarterly Services Survey. On the other hand, the CPI is based on a household survey done every two years by the Census bureau.
  3. The PCE basket is more comprehensive than the CPI basket. The CPI only includes out-of-pocket expenses, while the PCE includes services that are used by consumers but paid for by someone else. A good example is health insurance payments to doctors; the CPI only includes the out-of-pocket expense, while the PCE includes the amount your insurance company paid.

The Federal Reserve believes the PCE inflation rate is a more accurate measure of inflation, and investors should note the effect of using the PCE. Generally, the PCE inflation rate runs slightly below the CPI inflation rate. In the past two years, for example, the CPI finished up 3%, while the PCE was up only 2.4%.

US Personal Consumption Expenditures Price Index Chart

U.S. Personal Consumption Expenditures Price Index data by YCharts.

While it may not seem like much, if Social Security benefits or Treasury inflation-protected securities were indexed to the PCE instead of the CPI, it would mean billions less for the holders.

Besides providing a more accurate view of inflation, the PCE inflation rate is also one of the three key variables that the Federal Reserve is watching as it continues the drawdown of its quantitative easing and decides what to do with the federal funds rate. The other two are economic growth and the level of unemployment. As part of the Fed taper goes, the Fed has said it is aiming for PCE inflation of 2% to 2.5%. The PCE inflation rate has been half that level, worrying some that deflation could become a problem going forward. This is a problem that Europe is beginning to see.

How to protect yourself
Education is half the battle -- learning about the factors affecting markets and thereby you. The other half of the battle is how you invest both your time and your money.

It's Never Too Late to Start Investing
Millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet, those who've stayed out of the market have missed out on huge gains, and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important, and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Dan Dzombak can be found on Twitter @DanDzombak, or on his Facebook page, DanDzombak. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information