Personal Consumption Expenditures (PCE)

Summary:

Personal consumption expenditures (PCE) is a vital economic indicator, measuring the spending on goods and services by the people of the United States. It influences gross domestic product (GDP) and is used to gauge economic health and inflation. This article explores what PCE is, its components, the PCE Price Index, and its importance, making it essential reading for anyone interested in understanding the U.S. economy.

Understanding personal consumption expenditures (PCE)

Personal consumption expenditures (PCE), often referred to as consumer spending, plays a pivotal role in the U.S. economy, accounting for approximately two-thirds of domestic spending and significantly impacting GDP. PCE is meticulously calculated and reported by the Bureau of Economic Analysis (BEA) to track changes in consumer spending over time. This measurement not only reflects economic strength but also reveals how price fluctuations influence consumer behavior.

Components of PCE

PCE encompasses spending on both goods and services. To provide a comprehensive view, it breaks down into three main categories:

  • Durable goods: Items with a lifespan of over three years, such as cars, electronics, and furniture.
  • Nondurable goods: Products with a lifespan of under three years, including cosmetics, clothing, and gasoline.
  • Services: Tasks performed for the benefit of individuals, such as legal advice, healthcare, and transportation services.

These components allow economists and analysts to delve into consumer buying habits and savings patterns, influencing business decisions, hiring practices, and investments.

The PCE Price Index

The BEA releases the Personal Consumption Expenditures Price Index (PCEPI), which measures price changes and provides insights into inflation. The PCEPI consists of two versions: one covering all spending categories, and the other, known as the core PCE Price Index, excludes food and energy expenses. The latter is particularly useful for understanding underlying inflation trends, as food and energy prices tend to be more volatile.

Calculation of the PCE Price Index relies on PCE data and helps determine price inflation or deflation from one period to the next. This information is critical for understanding consumer spending behavior and its response to changing prices.

The Federal Reserve’s preference

The Federal Reserve has favored the PCE Price Index over the Consumer Price Index (CPI) for monetary policy decisions since 2012. Several factors contribute to this preference:

  • The PCEPI better reflects changes in consumer spending, considering shifts in purchasing patterns due to price changes.
  • It covers a broader range of spending categories.
  • Past data can be adjusted to accommodate recent information, offering a more comprehensive measure of inflation.

The PCEPI also benefits from more reliable data acquired through business surveys, making it a preferred choice over the CPI. Its formula accounts for short-term changes and variations in consumer behavior, making it a valuable tool for assessing economic growth.

Other measures of inflation

While PCEPI is a key measure of inflation, economists also track other indices like the Producer Price Index (PPI) and the Gross Domestic Product (GDP) Price Index to gain a complete perspective on economic trends.

How PCE is measured

The BEA reports the total value of personal consumption expenditures monthly, categorizing them into consumer goods and services. Durable goods, nondurable goods, and services comprise the consumer goods category, with each providing unique insights into consumer spending behavior.

Additionally, PCE reflects spending by nonprofit institutions, purchases of used goods, and transactions by U.S. residents in foreign countries. It also includes spending on behalf of households by third parties, such as employer-paid health insurance and pension plan expenses.

Advantages and disadvantages of PCE

Advantages

PCE data offers several advantages for economic analysis:

  • Provides a real-time view of the economy’s health.
  • Reports aggregate spending on a wide range of goods and services.
  • Changes in PCE can indicate economic growth or difficulties.

Disadvantages

However, PCE data also comes with its set of challenges:

  • Potential measurement errors during data collection and source data provision.
  • Classification errors may occur, affecting the accuracy of the data.
  • Historical revisions can lead to different interpretations of long-term trends.

Recent PCE readings

As of June 2023, personal income stood at $22.8 trillion, with disposable personal income at $19.9 trillion. PCE experienced a 0.5% increase, reaching $18.4 trillion. The PCE Price Index showed a 0.2% growth, reflecting changes in consumer prices.

The importance of personal consumption expenditures

The personal consumption expenditures number is a crucial indicator of economic health. Tracked monthly, it not only reveals how Americans collectively spend their money but also contributes to the PCE Price Index, which monitors inflation or deflation in consumer prices over time.

PCE Price Index vs. Consumer Price Index

While the Consumer Price Index (CPI) and PCE Price Index both track changes in the prices of a basket of goods and services, the PCE data for June 2023 indicated an increase in personal consumption expenditures to $18.4 trillion, a 0.5% growth, and contributed to a 0.2% growth in the PCE Price Index.

The bottom line

Personal consumption expenditures (PCE) is a fundamental economic metric that offers insights into the health of the U.S. economy. It illuminates consumer spending patterns, the impact of price changes, and helps guide governmental and business decisions. Understanding PCE is essential for anyone interested in comprehending the dynamics of the U.S. economy.

Frequently asked questions about PCE vs CPI

What is the difference between PCE and CPI?

PCE (Personal Consumption Expenditures) and CPI (Consumer Price Index) are both measures of inflation in the United States, but they have some key differences. PCE is based on the expenditures of individuals and reflects changes in the prices of goods and services that people actually consume. CPI, on the other hand, measures the average change in prices paid by urban consumers for a fixed basket of goods and services. While both indices track price changes, PCE is considered to have a broader coverage of spending and is favored by the Federal Reserve for its accuracy and relevance to consumer behavior.

Why does the Federal Reserve prefer PCE over CPI?

The Federal Reserve prefers PCE over CPI for several reasons. First, PCE is based on more comprehensive data, including actual consumer spending patterns, making it a more accurate reflection of consumer behavior. Second, PCE covers a broader range of spending categories, while CPI focuses on a fixed basket of goods and services. Third, PCE can be adjusted to accommodate recent data, allowing it to provide a more up-to-date measure of inflation. These factors make PCE a preferred choice for monetary policy decisions by the Federal Reserve.

How do PCE and CPI impact economic policy?

Both PCE and CPI play a crucial role in shaping economic policy in the United States. These inflation indices are used by policymakers to assess the health of the economy and make decisions related to monetary policy, interest rates, and government spending. When inflation is too high or too low, it can have significant implications for economic stability. Therefore, understanding the differences between PCE and CPI and their implications is essential for policymakers in making informed decisions to maintain a stable and healthy economy.

Do PCE and CPI always show the same inflation rate?

No, PCE and CPI do not always show the same inflation rate. While they are both measures of inflation, they use different methodologies and baskets of goods and services. As a result, their inflation rates can vary. In practice, PCE tends to show a slightly lower inflation rate than CPI, but the difference is usually not substantial. It’s important for policymakers and economists to consider both indices and their respective trends to get a more comprehensive view of inflation in the economy.

Which index is more relevant for consumers?

For consumers, CPI may be more relevant as it reflects the average change in prices of a fixed basket of goods and services typically purchased by urban consumers. CPI is often used to adjust things like Social Security payments and other cost-of-living adjustments. However, PCE, which reflects actual consumer spending patterns, provides valuable insights into how consumers adjust their spending in response to price changes. Both indices offer relevant information for consumers, but CPI may have more direct implications for certain financial aspects of daily life.

Are there other inflation indices besides PCE and CPI?

Yes, there are other inflation indices besides PCE and CPI. Some of the notable ones include the Producer Price Index (PPI), which measures price changes at the producer or wholesale level, and the GDP Price Index, which measures inflation in the prices of all goods and services included in the GDP. These indices serve different purposes and provide additional perspectives on inflation and its impact on the economy.

Key takeaways

  • PCE (Personal Consumption Expenditures) and CPI (Consumer Price Index) are both measures of inflation, but PCE reflects actual consumer spending patterns, while CPI uses a fixed basket of goods and services.
  • The Federal Reserve prefers PCE over CPI due to its broader coverage, accuracy, and ability to incorporate recent data.
  • Both PCE and CPI play a crucial role in shaping economic policy, influencing decisions related to monetary policy, interest rates, and government spending.
  • PCE and CPI may not always show the same inflation rate, with PCE typically showing slightly lower inflation.
  • For consumers, CPI may be more relevant, especially for cost-of-living adjustments, but PCE provides insights into consumer behavior in response to price changes.
  • Other inflation indices, such as the Producer Price Index (PPI) and the GDP Price Index, offer different perspectives on inflation and its impact on the economy.
View Article Sources
  1. CPI Vs. PCE Inflation: Choosing a Standard Measure – Federal Reserve Bank of St. Louis
  2. Measuring Inflation: CPI and PCE – Workforce Services (Utah.gov)
  3. PCE and CPI Inflation: What’s the Difference? – Federal Reserve Bank of Cleveland