PCEandCPIInflationDifferentialsConvertingInflation.pdfVIP

PCE and CPI Inflation Differentials: Converting Inflation Forecasts By Craig S. Hakkio he Federal Reserve recently announced it will begin to release quarterly inflation forecasts based on the Personal Consump- Ttion Expenditure Price Index. As Chairman Bernanke said, the PCE index is generally thought to be “the single most comprehensive and theoretically compelling measure of consumer prices.” At the same time, Bernanke said that “no single measure of inflation is perfect, and the Committee will continue to monitor a range of measures when forming its view about inflation prospects.” Another inflation measure the FOMC will continue to watch close- ly is the Consumer Price Index. The CPI is better known to the public than the PCE price index, and many contracts and government pro- grams are indexed to it. Both the CPI and the PCE index are important gauges of consumer inflation for policymakers and analysts concerned with price stability. The public and private sectors alike will want to be able to convert CPI inflation forecasts released by various organizations to PCE infla- tion forecasts, and vice versa. If the overall and core differentials between PCE and CPI inflation never changed, converting from one measure to Craig S. Hakkio is a senior vice president and special advisor on economic policy at the Federal Reserve Bank of Kansas City. This article, and the Model Specifications referenced in it, are on the bank’s website at www.KansasCityF. 51 52 Federal Reserve Bank of Kansas City the other would be as simple as converting temperatures from Celsius into Fahrenheit. But the inflation differentials can change significantly over time. For example, the overall inflation differential for the five years ending in mid-2002 fell from 0.6 percentage point to half that level over the next five years. At the same time, the core inflation differential fell ev