Understanding Inflation Data: The Differences Between PPI, CPI, and PCE

For those new to stock investing, data releases can be very confusing. A quick glance at an economic calendar reveals dozens of scheduled data points and scheduled news items every day, making it hard to know what is important and what is just noise. Then, even when you sort through all that information and work out what to pay attention to in general terms, the array of numbers in a category available can be overwhelming. Inflation data is a good example of that.

Most investors are aware that inflation, and the Fed’s response to it, are the big issues right now, but how is it measured? What is the difference between PPI and CPI, for example, and what is PCE? Which one matters most, or should we be looking at all of them? What do the different numbers in each set mean? These and many other questions make it hard to understand something that should be a simple economic problem -- rising prices that dampen demand. To answer all the questions, you first have to understand what each index and data set measures, so let’s start there.

Producer Price Index (PPI)

PPI measures the prices paid by companies for the goods and services they need to provide their products to consumers. It is sometimes referred to as “input prices” and is really a measure of underlying inflation. If the raw materials needed to produce something are getting more expensive, then those added costs will presumably be passed on to consumers, pushing up retail prices -- and therefore the cost of living.

You should remember, though, that this isn’t always true. Sometimes those higher input prices are absorbed by companies. Rather than increase prices, they may choose to just take the hit and reduce their profit margins. That is more likely when increases are deemed to be temporary, and temporary increases are more likely in commoditized things like food and energy. That is why the data include numbers that strip out those things and, for most analysts, the “ex-food and energy” number is taken as the one more indicative of underlying inflation.

Consumer Price Index (CPI)

CPI measure the increase in prices paid by urban households for the goods and services they buy and is measured by a survey conducted by the Bureau of Labor Statistics (BLS). Like PPI, it is presented in two basic forms, the month to month change in the index, and the change from the same month last year. The second of those is what people usually refer to when they talk about the “annual inflation rate,” or “headline inflation.”

CPI is also reported in terms of both an overall number and a core number that excludes food and energy. That may seem to make no sense in some ways, because what matters to you and me is how much we spend on food and gas each month, and that usually takes up a large part of our spending. However, economists and analysts are trying to get a handle on “sticky” inflation; food and energy prices, at least in theory, fluctuate depending on their underlying commodity costs and it's seen as a way of removing some noise from the data.

Personal Consumption Expenditure (PCE)

PCE is the Fed’s preferred measure of inflation because it has a couple of advantages over CPI as a measure of real price increases in the economy. First, it is derived from GDP data rather than from a survey, and economists prefer pure data to numbers that have a “personal opinion” element to them. Second, it is not just restricted to urban households, but also includes more remote, rural family expenditures.

Once again, it is expressed in both a base and core form, with the core excluding food and energy for the reasons give above. Core PCE is what the Fed says they watch most closely so, right now, where the Fed’s interest rate policy is dependent on what they view as underlying inflation, that is the most important number, even though it usually receives less attention in the mainstream media than “headline” CPI inflation.

As you can see, the term “inflation rate” is not as simple as it seems when you are using it to assess the prospects for the economy and for stocks. To get a complete picture of inflationary pressure, you have to understand all the data and why each set of numbers matter. Hopefully, if you have read this far, you are now better equipped to do that.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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