From the Desk of Daniel McCaffrey: How Close is The Fed to Target Inflation?
We’re all familiar with how inflation over the last few years has been affecting our day-to-day lives, perhaps more so than we’d prefer. One of The Federal Reserve’s two mandates is to achieve stable prices, currently targeting 2% annual inflation rate. To combat inflation, one of the main tools The Fed uses is the adjustment of interest rates. Many might remember the 9.1% inflation figure in June 2022, the highest 12-month Consumer Price Index (CPI) reading since 1981. However, while CPI numbers often grab headlines, The Fed gives precedence to the Personal Consumption Expenditures (PCE) index. In fact, the Federal Open Market Committee (FOMC) shifted its focus from CPI to PCE in the year 2000.
The primary reason for this preference is the flexibility of the PCE index to reflect changes in consumer behavior. Unlike CPI, the expenditure weights in PCE adjust as consumers substitute away from some goods and services toward others. A practical example is the seasonal increase in purchases of pumpkins in October, which the PCE can account for more dynamically than CPI. This, according to the FOMC, makes PCE a broader and more accurate measure of the inflation experience by typical consumers.
Turning to recent figures, the PCE for February 2024 was recorded at 2.5%, closely aligning with The Fed’s inflation target, in contrast to a CPI of 3.2% for the same period. This nearer alignment with their preferred measure suggests that The Fed is close to achieving its target inflation, influencing their approach to interest rates moving forward. As to how this will affect their future rate decisions, only time will tell. But the data shows The Fed is close to its target.
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