Upbeat music plays throughout.
Narrator: Policymakers, businesses, and investors all keep a close eye on inflation, which is the rise in the price of goods and services. A little bit of inflation is usually a sign of economic growth, while too much inflation can hurt the economy.
With millions of goods and services bought and sold every day, how do we know how inflation affects the whole economy? That's where the inflation indexes come in.
Inflation indexes gather price data from various sources across the economy and compile them into one number to give a snapshot view of how much things cost and how those costs are changing over different time periods. Seeing how much and how quickly prices are rising or falling can tell you a lot about economic growth, or the lack thereof, that drives financial markets and can impact your investment strategy.
There are three main inflation indexes that we'll focus on, which are best known by their acronyms: the CPI, the PCE, and the PPI. Each one is compiled differently and has a different purpose.
Let's start with the Consumer Price Index, or CPI. The CPI is released by the U.S. Bureau of Labor Statistics, or BLS, every month. Simply put, it's a measure of Americans' purchasing power and is used by policymakers to understand the cost of items over time.
To calculate the CPI, the BLS creates what's called a "basket," or collection of goods and services representing things the average American buys. In fact, it keeps an eye on the prices of tens of thousands of products and services, like housing and food, which are weighted and incorporated into the basket based on their estimated usage. When the BLS publishes that basket pricing info each month, it can be compared to previous months or years to get an idea of how prices are changing—or the percentage they're increasing.
Animation: A graph showings the approximate weights of each basket in the CPI. The baskets are, in order from greatest weight to least: Housing, Transportation, Food and Beverages, Medical Care, Education, Recreation, Apparel, and Other.
Narrator: For example, the CPI in October of 2023 was unchanged from September 2023 and up 3.2% year over year, which beat Wall Street projections and caused a stock market rally because it signaled an easing of inflation pressure.
CPI also plays a couple other roles, like helping determine increases to government benefits like Social Security and food stamps. It's also used to adjust Treasury Inflation-Protected Securities, or TIPS, a government bond where the principal changes with inflation.
Animation: A chart showing Consumer Price Index year-over-year change as of October 2023 for four baskets: All items and food are near 3%, energy fell more than negative 4%, and core inflation is close to 4%.
Narrator: Some economists like to strip out data about food and energy, the more volatile goods and services, for a more stable measurement known as core inflation. Prices for both categories can swing violently in either direction, sometimes muddying long-term trends.
There's similar thinking behind another common inflation index, the Personal Consumption Expenditures Price Index, or PCE. The PCE is released monthly by the Bureau of Economic Analysis and is similar to the CPI in that it measures the price that consumers pay for goods and services. The distinction is that it weights the categories that comprise it differently.
Animation: Comparing the approximate weights of the CPI and PCE, housing is smaller in PCE than in CPI, while food and beverage is slightly larger in PCE. There are small differences in transportation, medical care, education, recreation, apparel, and other.
Narrator: Where the CPI checks in on 80,000 products, the PCE includes additional data like spending by the government and employers, representing closer to 100% of the U.S. economy. As a result, the PCE weights the categories of its "basket" differently than the CPI.
The extra data going into the PCE is why it's considered more accurate than the CPI. It's also why the Fed uses the PCE as its primary inflation metric when determining monetary policy.
The Fed has a target inflation rate of 2%, which is considered a stable level in terms of economic growth and price stability.
While PCE data from 2023 still showed price in an upwards trajectory, the monthly percentage change was more in line with historical averages, especially when compared with the drastic swings during the pandemic in 2020.
While the consumer spending that the PCE and CPI track is important, the costs to producers of good and services is also significant for inflation. That's what the Producer Price Index, or PPI, tracks. It's released monthly by the BLS and reflects a survey of 25,000 establishments that send approximately 100,000 price quotations every month.
PPI compares that data for the current year against a baseline year in order to give a measurement of how it changes.
The information is useful in a lot of ways. Producers can compare prices of a given product or industry to inform their pricing strategy. It can also be used to foreshadow price changes for consumers. The assumption being if producers are paying more for wholesale goods, they'll likely try to pass those increased costs to consumers. The government uses the PPI to inform its monetary and fiscal policies aimed at limiting inflation.
From October 2022 through October 2023, the PPI saw a wholesale price increase of 1.3% across the board.
It was drastic improvement from March 2022, when headline PPI saw a wholesale price increase of 11.7%.
The CPI, PCE, and PPI together can paint a picture of inflation in the United States. Inflation can affect the performance of individual investments, and investors can use it to investigate broader trends. It's also a key indicator the Fed uses when setting interest rates, which can have major consequences throughout the markets. They're another useful tool in your investor toolbelt.
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