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The Bureau of Economic Analysis is changing how it calculates key components of the Personal Consumption Expenditures (PCE) deflator, the Fed's preferred inflation gauge. These changes will lower the reported inflation figure, complicating year-over-year comparisons and Fed policy analysis.
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The host argues that the Consumer Price Index (CPI) is misunderstood. It is not a simple collection of observed prices but a complex calculation involving a significant number of "imputed" or estimated values. Understanding this is crucial to interpreting inflation data correctly.
After accounting for measurement quirks in both CPI and PCE, the podcast's economists converge on an estimate for "true" underlying inflation around 2.7-2.8%. This consensus view suggests that while official measures are noisy, the underlying trend is still meaningfully above the Fed's 2% target.
The gap between Core PCE (3.3%) and Core CPI (2.5%) inflation is driven by how each index weighs shelter and measures financial services. CPI gives more weight to disinflating shelter, while PCE is inflated by a stock market-linked measure for financial services.
Due to budget and staffing cuts at the Bureau of Labor Statistics, more than 33% of the Consumer Price Index is now estimated rather than directly surveyed. This significant increase in imputation questions the reliability of a key metric for economic policy.
Upcoming technical changes by the Bureau of Economic Analysis will mechanically lower reported core PCE inflation by 0.2 to 0.3 percentage points. This is primarily due to a new methodology for measuring financial services, creating an artificial cooling in the data that the Fed is likely to look through.
Due to budget cuts at the Bureau of Labor Statistics (BLS), roughly 20% of all prices in the CPI are now imputed, up from just 2-3% a year ago. This increases the margin of error and reduces confidence in official inflation statistics.
A measure of "market-based core PCE services ex-housing" inflation is accelerating. This niche metric, which strips out imputed prices and volatile sectors, suggests that core economic activity is generating persistent inflation, challenging narratives focused solely on energy shocks or trade wars.
The Bureau of Economic Analysis will soon change how it calculates financial services prices for the PCE deflator. It's moving from a stock market-based measure to one based on wages, a change expected to reduce year-over-year Core PCE by 0.1-0.2 percentage points.
A key but overlooked issue with the Consumer Price Index (CPI) is the deteriorating quality of data imputation. An increasing percentage of missing data points are being filled using less-similar items ("different cell" imputation). This degradation in methodology introduces a hidden risk to the reliability of the headline inflation numbers.
The new Fed Chair's suggestion to use measures like the trimmed-mean CPI isn't new. These same metrics were used by Fed governors in 2021 to justify delaying rate hikes. They failed to capture the breadth of rising inflation then, which suggests caution should be used before elevating them as primary policy guides now.