As the inflation story continues to drag on longer than anyone hoped or expected, we continue to
dissect it and present our findings to clients. In those discussions, a few questions keep surfacing. Here are a few answers:
Inflation simply refers to the change in prices, typically reported on a year-over-year basis. If
an apple cost $1.00 last year but costs $1.10 this year, the ten cent increase amounts to 10%
inflation. However, if the price of the apple falls to $0.90, it is said to have experienced
deflation. To make things confusing, a third term was added: disinflation. If the price of our
apple increased 10% in 2022 and 5% in 2023, it experienced disinflation – prices rising at a slower
rate. It is important to understand that zero inflation suggests zero price change. It does not
suggest prices will revert to prior levels.
CPI is an estimate of the average price change of a basket of items. According to official data,
prices of nearly 80,000 items are collected for the index. Roughly 21,000 consumers are surveyed to
determine which items should be included in the basket. The items are then weighted based on
importance. Consumers spend a larger share of their income on housing than on apples so housing
carries a higher weight (importance) in the index.
CPI was not intended to be a cost-of-living index (although the Social Security Administration uses
it for that purpose). CPI was intended to be an economic indicator, designed to help officials
monitor price changes. Core CPI is a subset of CPI which excludes food and energy. It has proven to
be a more accurate predictor of future inflation and consequently, more often cited by Fed
officials.
PCE is a similar measure of inflation, administered by a different government agency, using a
different basket of goods and different weights. This provides officials with a second estimate
for inflation. Once again, Core PCE is a subset of the PCE index which removes food and energy and
is a favored tool for forecasting purposes.
PPI, in contrast, measures changes in producer (wholesale) prices rather than consumer prices,
providing officials with a view of underlying inflation pressure.