Inflation Metrics
Primary sources: Bureau of Labor Statistics (CPI, PPI), Bureau of Economic Analysis (PCE), Federal Reserve Banks of Dallas (Trimmed Mean PCE) and Atlanta (Sticky-Price CPI), and U.S. Treasury (TIPS breakevens).
The Fed's 2% Inflation Target
In January 2012, the FOMC formally adopted a 2% inflation target measured by the annual change in the PCE price index. In August 2020, the Fed adopted "flexible average inflation targeting" (FAIT), meaning it would seek inflation that averages 2% over time and would tolerate periods of moderately above-2% inflation following periods when inflation ran persistently below 2%.
The choice of PCE over CPI was deliberate. PCE is broader in scope, accounts for substitution behavior, and is less influenced by shelter costs (which have an outsized weight in CPI). However, CPI remains the more widely cited measure in public discourse and is used for Social Security cost-of-living adjustments and Treasury Inflation-Protected Securities (TIPS) indexation.
CPI vs. PCE: Key Differences
| Dimension | CPI | PCE |
|---|---|---|
| Source agency | Bureau of Labor Statistics | Bureau of Economic Analysis |
| Scope | Out-of-pocket spending by urban consumers | All consumer spending, including employer-paid (e.g., health insurance) |
| Weighting | Fixed basket, updated every 2 years | Chain-weighted; adjusts for substitution monthly |
| Shelter weight | ~36% (as of 2024) | ~16% |
| Fed's target measure | No (but used for TIPS and COLA) | Yes (Core PCE for 2% target) |
Inflation Metrics Reference
Consumer Price Index (CPI)
Measures the average change in prices paid by urban consumers for a fixed basket of goods and services. Based on prices collected from approximately 80,000 items in 75 urban areas. The most widely cited inflation measure in media and for COLA adjustments.
Core CPI (ex-Food and Energy)
CPI excluding food and energy components, which are volatile and subject to supply shocks. Considered a better measure of underlying inflation trends. However, critics note that food and energy are significant household expenses.
Personal Consumption Expenditures (PCE)
Derived from the GDP accounts. Broader than CPI -- captures all consumer spending, not just out-of-pocket costs. Uses chain-weighted methodology that accounts for substitution effects (when consumers switch to cheaper alternatives).
Core PCE (ex-Food and Energy)
The Federal Reserve's preferred inflation measure for its 2% target. Excludes food and energy. Uses the broader PCE scope and chain-weighting methodology. Published as part of the Personal Income and Outlays report.
Producer Price Index (PPI)
Measures the average change in selling prices received by domestic producers. A leading indicator of consumer inflation -- price increases at the producer level often pass through to consumer prices with a lag.
Trimmed Mean PCE
Removes the most extreme price changes (both high and low) from the PCE basket each month and calculates the weighted average of the remaining components. Designed to capture the signal in inflation data by reducing the influence of outliers.
Sticky-Price CPI
Separates CPI items into 'sticky' prices (those that change infrequently, like rent and medical care) and 'flexible' prices (those that change often, like gasoline and food). Sticky prices are thought to better reflect inflation expectations.
Breakeven Inflation Rate (5-Year)
Difference between the 5-year nominal Treasury yield and the 5-year TIPS (Treasury Inflation-Protected Securities) yield. Represents the market's expectation of average annual inflation over the next 5 years. Also called the inflation compensation rate.
Breakeven Inflation Rate (10-Year)
10-year equivalent of the breakeven rate. Widely used as a market-based measure of long-term inflation expectations. The Fed monitors this closely alongside survey-based measures (Michigan, SPF).
How Inflation Metrics Are Calculated
CPI is calculated using a modified Laspeyres index -- it measures the cost of purchasing a fixed basket of goods at current prices relative to a base period. The basket is updated every two years based on the Consumer Expenditure Survey. Within the two-year cycle, CPI uses a geometric mean formula at the item level to partially account for substitution within categories (e.g., between types of apples), but the category weights remain fixed.
PCE uses a Fisher Ideal index (chain-type), which fully accounts for substitution between categories by updating weights monthly. This means PCE tends to run slightly lower than CPI over time -- historically about 0.3 percentage points lower on an annual basis -- because it captures the effect of consumers shifting spending toward relatively cheaper goods and services.