The Federal Open Market Committee (FOMC), the decision-making arm of the U.S. Federal Reserve (Fed), adjusts interest rates to help keep inflation near a 2% target. The FOMC's preferred measure of inflation is the Price Index for Personal Consumption Expenditures (PCE), primarily because it covers a broad range of prices and picks up shifts in consumer behavior. The Fed also focuses on core inflation measures, which strip out volatile food and energy categories that are less likely to respond to monetary policy.
The typical American might be more familiar with the Consumer Price Index (CPI), which was the Fed's favorite inflation gauge until 2012. A subset of the broader index, called the Consumer Price Index for All Urban Consumers (CPI-U), is used to determine cost-of-living adjustments for federal income taxes and Social Security.
The CPI only measures the prices that consumers actually pay for a fixed basket of goods, whereas the PCE tracks the prices of everything that is consumed, regardless of who pays. For example, the CPI includes a patient's out-of-pocket costs for a doctor's visit, while the PCE considers the total charge billed to insurance companies, the government and the patient.
Another difference is in the ways the indexes track expenditures over time. The PCE uses current and past spending to capture consumers' tendency to substitute less expensive goods for more expensive items. By contrast, the weighting of CPI categories is adjusted every two years, so the index does not respond quickly to changes in consumer spending habits. It nevertheless provides a good comparison of prices over time.
According to the CPI, inflation rose 2.1% in 2016 — in line with the 20-year average of 2.13% and the Fed’s current target.1 This level of inflation may not seem like a big strain on the family budget, but even moderate inflation can have a negative impact on overall purchasing power. In addition, inflation can reduce the real returns of investments over time, so it’s another factor to consider when planning for investing goals.
Of course, if inflation picks up speed, it could become a more pressing concern for consumers and investors.
1 U.S. Bureau of Labor Statistics, 2017 (data through December 2016)
Need more insight? Let us be your guide.
Our national network of experienced financial advisors can help you create a personalized plan to help you identify financial goals and get you where you want to go in life.Find an Advisor
This information is prepared by an independent third party, Broadridge Investor Communication Solutions, Inc. and is provided for informational and educational purposes only. Waddell & Reed believes the information has been obtained from sources considered to be reliable, but does not guarantee the accuracy of the information provided. This information is not meant to be a complete summary or statement of all available data necessary for making financial or investment decisions and does not constitute a recommendation.
Please note that the information provided may include references to concepts that have legal, accounting and tax implications. It is not to be construed as legal, accounting or tax advice, and is provided as general information to you to assist in understanding the issues discussed. Neither Waddell & Reed, Inc., nor its Financial Advisors give tax, legal, or accounting advice.
This information is not meant as financial or investment advice pertaining to your personal situation. The selection of appropriate investment, insurance or planning options and/or strategies should be made on an individual basis after consultation with appropriate legal, tax and financial advisors. Nothing contained herein is intended as a solicitation or an offer to buy or sell any product or service mentioned and they may not be suitable for all investors. Securities offered through Waddell & Reed, Inc., Member FINRA/SIPC, are not insured by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financial institution, and are subject to risks, including the possible loss of principal. Insurance products are offered through insurance companies with which Waddell & Reed has sales arrangements. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.
Securities offered through Waddell & Reed, Inc., Member FINRA/SIPC, are not insured by FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financial institution, and are subject to risks, including the possible loss of principal. Insurance products are offered through insurance companies with which Waddell & Reed has sales arrangements. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.