Median PCE Inflation

• Description: We calculate the median PCE inflation rate based on data released in the Bureau of Economic Analysis’ monthly Personal Income and Outlays report.
• Median PCE inflation is the one-month inflation rate of the component whose expenditure weight is in the 50th percentile of price changes.
• Benefits: By omitting outliers (small and large price changes) and focusing on the interior of the distribution of price changes, the median PCE inflation rate can provide a better signal of the underlying inflation trend than either the all-items PCE price index or the PCE price index excluding food and energy (also known as the core PCE price index).

Background

Description

The personal consumption expenditures (PCE) price index covers a broad range of goods and services and provides a general overview of the prices of things that are purchased directly by, or on behalf of, households. But because the PCE price index includes items whose prices rise and fall frequently, such as food and energy, the PCE price index is not well-suited to measure the underlying rate of inflation, or the rate of inflation that is likely to persist over medium-run horizons of several years.

A number of measures have been developed to measure underlying inflation. The PCE price index excluding food and energy prices (core PCE price index) removes price changes of the same items from the PCE price index each month—namely, food and energy prices—because they are typically the most volatile. The median PCE inflation rate uses a different approach and excludes all price changes except for the one in the center of the distribution of price changes, where the price changes are ranked from lowest to highest (or most negative to most positive). So in calculating the median PCE inflation rate, the items excluded from the PCE price index change from month to month.

Research from the Cleveland Fed shows that the median PCE inflation rate can be useful for estimating the underlying trend in inflation and forecasting future inflation.

How Median PCE Inflation Is Calculated

To calculate the median PCE inflation rate, the Federal Reserve Bank of Cleveland looks at the full set of price categories for goods and services published by the Bureau of Economic Analysis (BEA). But instead of calculating an inflation rate that is a weighted average of all of the items in the PCE price index, as the BEA does, the Cleveland Fed ranks the inflation rates of the components of the PCE price index and picks the one in the middle of the distribution—that is, the item whose expenditure weight is in the 50th percentile of the price change distribution. The Federal Reserve Bank of Dallas produces an alternative measure, the Trimmed Mean PCE inflation rate, which asymmetrically removes or trims the upper and lower tails of the distribution of price changes.