Several years ago, when inflation had decelerated from its high peaks, I published an article in the Wall Street Journal about inflation and the Fed. It’s always an honor to get a piece in the WSJ, but one of the hazards is the WSJ holds the right to put any title on the article that it wishes. In almost all cases, the WSJ’s title is far better than the ones I have submitted. For my article on October 26, 2023, I liked my title, “Lower Inflation but Higher Prices” more than the title the WSJ used: “We’re Still Paying for the Federal Reserve’s Blunders”.
Both titles still apply to the current situation. PCE inflation is 2.7% and CPI inflation is 3.0%--which may seem modest, but the cumulative increase in prices for goods and services is the primary focus of consumers. It directly influences their standards of living, their perceptions of confidence and their assessments of government leadership. Meanwhile, the focus of financial markets and the Fed is nearly exclusively on the rate of inflation and changes in the rate, to the tenth of a percent and beyond. Presently, even amid lack of government data, the focus in financial markets is the extent to which PCE inflation is above the Fed’s 2% target, and what is the appropriate policy rate that would eventually reduce inflation to 2%.
This note considers the cumulative increase in the level of price increases in recent years and adds in an important element—how relative prices of different goods and services have changed, particularly some of the things we purchase on a regular basis—food and drink. Prices of some goods and services have gone up much more or less than others. Presumably, this is affecting household pocketbooks and our spending patterns.
The trend in inflation. As shown in Charts 1 and 2, CPI and PCE inflation have settled down but the cumulative increase in the general price level has been striking—since pre-Covid, measured as 2019Q4, the CPI is up 26.9% and the PCE is up 22.3%. That’s the biggest cumulative increase in prices over a short number of years since the 1970s. (It’s nearly unimaginable that during the Great Inflation between 1966 and 1982, the CPI rose 300%...while the S&P500 rose 150%). Nevertheless, the recent surge in the general price level comes as a rude awakening following the stable and relatively low inflation that persisted in the decade following the Great Financial Crisis.
Two quick footnotes. First, while the PCE Price Index provides a more comprehensive measure of inflation by including prices of all goods and services consumed, the CPI is a much better measure of consumers’ out-of-pocket expenses. The PCE is a price index of all consumption, whereas the CPI does not include prices of goods and services that are financed by third party payers, including health care services financed by Medicare, Medicaid and employer health insurance. Accordingly, the CPI has a significantly higher weighting of housing services (rental costs and owners’ equivalent rent of residencies, or OER) while the PCE has a much higher weighting of health services.
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