Magazine article Economic Trends

Evaluating Progress toward the Fed's Inflation Target

Magazine article Economic Trends

Evaluating Progress toward the Fed's Inflation Target

Article excerpt

[GRAPHIC OMITTED]

[GRAPHIC OMITTED]

Since January 2012, the Federal Open Market Committee (FOMC) has explicitly stated an inflation target of 2 percent. Since that time, most measures of inflation have been running persistently below that target. While in recent months some inflation indicators have made progress in moving back toward 2 percent, determining just how close we are to the FOMC's target depends on which inflation measure we look at.

For example, measures based on the Personal Consumption Expenditures (PCE) price index indicate that progress has been made toward the 2 percent inflation target but that inflation still remains somewhat below the desired level. The year-over-year percent change in the PCE price index, which remained below 1.5 percent since early 2013, ticked up to near 1.7 percent in May and was at 1.6 percent in June. Additionally, inflation as measured by the core PCE price index, which excludes food and energy costs and is therefore a less volatile measure of underlying inflation, increased to 1.5 percent by June after staying in a narrow range around 1.3 percent over most of the past year.

In contrast, measures based on the Consumer Price Index (CPI) give a different impression of where we are in relation to a 2 percent target. The year-over-year percent change in the CPI increased to 2.0 percent in April of this year and has remained near that level through July. Core CPI inflation increased to 2.0 percent in May, and as of July, was at 1.9 percent. Evaluating current inflation levels with the CPI could lead us to think that we have been right on target over the past few months.

But it isn't quite right to use common CPI measures of inflation to assess proximity to the FOMC's longer-run inflation goal. The FOMC's target is based on the Committee's preferred measure of inflation--the PCE price index. Normally, CPI inflation runs higher than PCE inflation; since 2001, the difference has been about 0.4 percentage points. There are a number of reasons that CPI inflation commonly exceeds PCE inflation, having to do with the different purposes of the price measures and their construction.

[GRAPHIC OMITTED]

[GRAPHIC OMITTED]

One of the primary drivers of the difference in PCE and CPI inflation rates is known as substitution bias. As the price of one good goes up relative to another, consumers will make substitutions in their purchases, to spend less on the now more expensive good and more on the newly cheaper item. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.