US & World Economies Economic Terms PCE Inflation, How It's Calculated, and Why the Fed Prefers It Why the Fed Uses a Special Measurement for Inflation By Kimberly Amadeo Updated on March 4, 2021 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Sponsored by What's this? & In This Article View All In This Article How It's Calculated PCE Price Index vs. CPI Why the Fed Prefers the PCE Core PCE Inflation Photo: Photo by Rubberball/Mike Kemp/Getty Images The Personal Consumption Expenditures Price Index (PCEPI) measures price changes for household goods and services. Increases in the index warn of inflation while decreases indicate deflation. The PCEPI is also called the PCE price index. Of all the measures of consumer price changes, the PCEPI includes the broadest set of goods and services. How It's Calculated The Bureau of Economic Analysis (BEA) estimates the PCE price index each month and publishes its findings in a report called "Personal Income and Outlays." The BEA uses the same data that creates the quarterly gross domestic product (GDP) report that measures U.S. economic output but the PCE price index measures consumer purchases through different calculations: The BEA estimates how much is being consumed based on the GDP data from suppliers. That figure includes manufacturers’ shipments, revenue for utilities, service receipts, and commissions for securities brokerage. It adds imports, which the GDP report excludes. The BEA then subtracts exports and changes in inventory to determine the amount available for domestic consumption. It allocates the result of step three among domestic purchasers. It bases this on trade source data, Census Bureau data, and household income surveys. The BEA converts the prices, which are still the producers' prices, to the end price paid by the consumer. It bases the prices on the Consumer Price Index (CPI). Note The PCE price index includes estimates from other price sources, which makes it a little more broadly based than the CPI. It adds the cost of profit margins, taxes, and transportation costs. The BEA includes data from the Census Bureau’s Economic Censuses, International Transactions Accounts, and various government agencies. For example, the price for food that is grown and eaten on the farm is derived from the Department of Agriculture or the USDA. Since the GDP report is quarterly and the PCE price index is estimated monthly, the BEA must estimate even further to fill in the gap, so it uses the monthly retail sales report. PCE Price Index vs. CPI Although they both measure inflation, there are subtle differences between the PCE price index and the CPI. The most noticeable difference is that the PCE price index is not as well known as the Consumer Price Index. The PCE index uses data from the GDP report and businesses, while the CPI uses data from household surveys the Bureau of Labor Statistics creates. It surveys around 14,500 families and collects prices for about 80,000 consumer items. The CPI includes sales taxes but not income taxes. Note The PCE price index collects data on some different types of goods and services than the CPI does. The PCE price index counts health care services paid for by employer-sponsored health insurance, Medicare, and Medicaid. The CPI only counts medical services paid for directly by consumers. The PCE price index measures goods and services bought by all U.S. households and non-profits. The CPI only measures all urban households. The PCE price index and the CPI use different types of formulas to calculate price changes. The CPI formula is more likely to be affected by categories with wide price swings such as computers and gasoline. The PCE calculations smooth out these price swings, which makes the PCE less volatile than the CPI. PCE vs. CPI Comparison PCE Lesser known Uses data from the GDP report Includes costs incurred by health insurance All U.S. households Less affected by wide price swings CPI Most popular Data is from a household survey Only includes consumer health costs Only measures urban households Affected by wide price swings The Fed's Preferred Measure of Inflation On Jan. 15, 2012, the Federal Reserve stated at its monthly Federal Open Market Committee meeting that it would use the PCE price index as its primary measure of inflation. The Fed preferred the PCE for three primary reasons: The PCE formula responds more fluidly to changing consumer preferences.It includes a more comprehensive list of expenditures.Historical data can be revised to reflect new data. Core PCE Inflation The core PCE price index measures core inflation. It excludes volatile oil, gas, and food prices. By excluding those categories, it gives a better look at underlying inflation trends. Why are oil, gas, and food prices so volatile? The commodities markets determine oil prices, which consequently affect gas and then food prices. When traders expect oil supply or demand to change, they speculate on oil prices. The strength of the dollar also affects oil prices. The core PCE price index removes that volatility and gives an accurate picture of real inflation. It reports on all types of inflation. Note The Fed uses the core inflation rate because food, oil, and gas prices move so rapidly, especially in the spring and summer. The Fed compares the core PCE inflation rate to the Fed's 2% target inflation rate. If it is below 2%, the Fed will lower interest rates and use its other tools to spur consumer demand. If the core rate is above 2% for an extended period, then the Fed will take action to prevent inflation. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Bureau of Economic Analysis. "Prices and Inflation." Federal Reserve Bank of San Francisco. "PCE Inflation Dispersion." Bureau of Economic Analysis. "Personal Income and Outlays." Bureau of Economic Analysis. "Chapter 5: Personal Consumption Expenditures." Page 5-8. Bureau of Economic Analysis. "Chapter 5: Personal Consumption Expenditures." Pages 5-7. Bureau of Economic Analysis. "Chapter 5: Personal Consumption Expenditures." Pages 5-14. Bureau of Economic Analysis. "Chapter 5: Personal Consumption Expenditures." Pages 5-9. Bureau of Labor Statistics. “Consumer Price Index Frequently Asked Questions.” Bureau of Economic Analysis. "A Reconciliation between the Consumer Price Index and the Personal Consumption Expenditures Price Index." Page 12. Bureau of Economic Analysis. "A Reconciliation between the Consumer Price Index and the Personal Consumption Expenditures Price Index." Page 3. Bureau of Economic Analysis. "A Reconciliation between the Consumer Price Index and the Personal Consumption Expenditures Price Index." Page 10. Board of Governors of the Federal Reserve System. "Federal Reserve Issues FOMC Statement of Longer-Run Goals and Policy Strategy." Board of Governors of the Federal Reserve System. "Monetary Policy Report to the Congress Pursuant to the Full Employment and Balanced Growth Act of 1978." Page 4, Footnote 1. Bureau of Economic Analysis. "What Is the Core Price Index?" Board of Governors of the Federal Reserve System. "Why Does the Federal Reserve Aim for Inflation of 2% Over the Longer Run?"