What Are the Consumer Price Index and Core Price Indexes

The Consumer Price Index (CPI) is one of the key indicators that anyone investing in stocks or Bitcoin makes sure to keep an eye on. A price index is a core measure of a country's inflation. It is also one of the important factors for gauging how central banks, such as the US Federal Reserve, will adjust the pace of interest rate hikes. So how do you read and analyze the CPI? And did you know there are other important price indexes besides the CPI?

What Is the CPI?

CPI stands for the Consumer Price Index. The items it measures include food, energy, cars, clothing, real estate, housing, healthcare and more. In other words, it is calculated by combining the prices of things that are essential to everyday life. To sum up, the Consumer Price Index measures changes in the prices of the overall goods and services people need to live in a given country.

Besides the CPI, there is another price index called the PCE. Many people look at the CPI, but the reason I bring up the PCE is that the Fed bases its interest rate decisions mainly on the PCE. You have probably heard that the Fed's inflation target these days is 2%. That figure is based on the PCE.

What Is the PCE?

PCE stands for Personal Consumption Expenditures, and it refers to the Personal Consumption Expenditures Price Index. Let's compare it with the CPI. As mentioned above, the CPI has fixed weights for each item. In other words, it measures price changes in the same items every month. The PCE, however, gives more weight to the items consumers actually buy more of.

Let me give you an example. Imagine that one day electric cars become mainstream and everyone drives one. In that case, the figures for crude oil, one of the key components the CPI currently measures, would become less realistic than they are now. The PCE, on the other hand, adds consumers' spending on electric cars into actual consumption patterns when determining the price index.

In short, the PCE reflects the prices people actually feel in a more realistic way. In the US in particular, personal consumption expenditures make up about 70% of the nation's spending, so measuring personal consumption expenditure prices is important.

And What Are Core Price Indexes?

Finally, let's take a look at core price indexes. In English, the word "core" is added in front. In other words, there are also Core CPI and Core PCE. A core price index is calculated by excluding goods with large price swings, such as energy and food. Why exclude these two categories? Because a price index based on the less volatile goods and services in the remaining categories gives a better outlook on long-term inflation trends.

That wraps up our look at the concepts of CPI and PCE and how to read them. Most people look at the CPI, but the indicator the Fed directly relies on for its decisions is the PCE. It is also a good idea to check Core CPI/PCE as well. You can find the CPI at the US Bureau of Labor Statistics. The PCE can be found at the US Department of Commerce's Bureau of Economic Analysis.