Wednesday, 22 of November of 2017

Economics. Explained.  

Personal Consumption Expenditures Deflator

June 30, 2017

There are many different measures of inflation, but the one that the Federal Reserve considers to be most important is the personal consumption expenditures deflator, in particular the PCE deflator excluding the volatile food and energy components.

The PCE deflator declined 0.1% in May after having risen 0.2% in April.  The year-over-year increase now stands at 1.4%.

Excluding the volatile food and energy components the PCE deflator rose 0.1% in both April and May.  The year-over-year increase is now 1.4%.  It is being held down in recent months by a price war in the wireless cell phone industry and falling prescription drug prices as Trump is putting pressure on the industry.  Falling prices in those two sectors will not continue.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach the 1.8% mark by the end of 2017 and 2.2% by the end of next year.  This inflation gauge has gone from being below the Fed’s inflation target to being almost to its target.  The Fed is likely to raise the funds rate one more  time in 2017 which would lift the funds rate to the 1.25% mark (which is still very low).

The more widely known inflation measure, the CPI ex food and energy, has been rising at a somewhat faster pace and is projected to increase 2.0% in 2017 and 2.5% in 2018.

Why the difference?  The CPI measures price changes in a fixed basket of goods each month.  The deflator captures price changes, but also changes in consumer spending habits.  If we try to save money by switching from butter to lower-priced margarine, from beef to chicken, or if builders substitute PVC pipe for more expensive copper,  the deflator would come in lower than the CPI in that particular month.  For our money, we think that the CPI which strictly measures price changes is a better barometer of inflation.  The Fed disagrees.

Stephen Slifer


Charleston, SC

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