Yahoo Finance’s Josh Schafer joins the Live show to break down what PCE means and why it matters.

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The personal consumption expenditures (PCE) index, which is one of the Federal Reserve’s favorite measures of inflation, measures the change in prices of goods and services purchased by consumers. This is a crucial metric in determining the health of the economy, and the Fed uses it to make interest rate decisions and forecast inflation trends.

PCE is often broken down into two subcategories: “core” and “headline”. The core PCE index excludes volatile items such as food and energy prices, which can fluctuate significantly due to external factors such as weather or geopolitical tensions. The headline PCE index, on the other hand, includes all goods and services.

PCE is calculated by comparing the prices of a specific basket of goods and services over time. This basket is updated regularly to reflect changes in consumer behavior and the availability of goods and services. The PCE index uses a weighted approach to give more importance to items that are purchased more frequently or are more essential to daily life.

The Fed prefers the PCE index because it provides a more accurate picture of inflation trends. The Consumer Price Index (CPI), another widely cited inflation gauge, uses a fixed basket of goods and services that is only updated every few years. This means that changes in consumer behavior or the availability of goods and services can cause CPI to be less accurate and potentially misleading.

In recent years, the PCE index has remained below the Fed’s 2% inflation target, which has led the Fed to keep interest rates lower in an effort to boost inflation. However, since the onset of the COVID-19 pandemic, inflation has started to rise, driven in part by supply chain disruptions and increased demand for goods and services. As a result, the Fed has signaled that it may start to raise interest rates in the near future to prevent inflation from getting out of control.

In conclusion, the PCE index is an important metric for measuring inflation trends in the economy. While it has remained below the Fed’s target for several years, recent increases in inflation have signaled that the economy is heating up. As the Fed considers interest rate decisions in the coming months, the PCE index will continue to be a key factor in these decisions.