Because the CPI measures
out-of-pocket consumer spending, it may be a better indicator of
household infl ation expectations. The “on behalf of consumer” spending
captured in the PCE is probably not something consumers think about when
they think about costs. Consumers only consider out-of-pocket spending,
not spending by their employers or the government in them.
If the CPI does indeed better estimate infl ation expectations than the PCE, then it being near 2% (and not near 1%) is a good thing. It means that consumers may not be thinking prices are going down, or in other words, expecting defl ation. In defl ationary environments, people save, not spend. Expected deflation also means higher real interest rates (recall that real rates are a function of expected inflation, not actual inflation). Lower spending and higher real rates are Bernanke’s fears. Like the Economist’s Free Exchange blog, I’d worry if the core CPI moved down to the core PCE 1% growth rate range, but for now, the core CPI suggests infl ation expectations are okay.
If the CPI does indeed better estimate infl ation expectations than the PCE, then it being near 2% (and not near 1%) is a good thing. It means that consumers may not be thinking prices are going down, or in other words, expecting defl ation. In defl ationary environments, people save, not spend. Expected deflation also means higher real interest rates (recall that real rates are a function of expected inflation, not actual inflation). Lower spending and higher real rates are Bernanke’s fears. Like the Economist’s Free Exchange blog, I’d worry if the core CPI moved down to the core PCE 1% growth rate range, but for now, the core CPI suggests infl ation expectations are okay.
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