CPI vs PCE inflation
CPI is the consumer-price index — the one in headlines, COLA adjustments, and TIPS. PCE is the personal-consumption-expenditures deflator — the Fed's official target, broader in scope and smoother in weighting. They usually move together but can diverge meaningfully at turning points.
Why the Fed prefers PCE
PCE weights adjust dynamically — it captures substitution (buying chicken when beef spikes) that fixed-basket CPI misses. It's also broader: healthcare paid by employers and government counts in PCE but not CPI. The Fed's 2% target is in PCE terms; headline CPI typically runs ~0.3–0.4pp hotter.
Why it matters for signals
Inflation drives the policy response — the rate path that inverts curves and cracks housing. The 2021–22 episode showed why composition matters: headline CPI hit 9% on energy and goods while core PCE ran cooler; the Fed's tightening decision tracked the core measure, and so did the recession risk that followed.