What’s Inflation? It’s The Fed’s Answer That Counts

David Reavill
5 min readNov 3, 2023

If you were asked: “what’s inflation?” it’s likely that you might give a couple of different answers. On the one hand, you might say: “It’s when prices rise.” Or, on the other hand, you may respond: “It’s when things cost more.” Both answers would be correct. But there’s a mile’s worth of difference between the two. And that difference is going to have a profound impact on our economic future.

Our government, which assembles most of our economic data, has yet to decide which definition to use, so they use both. One agency, the Bureau of Economic Analysis, uses “cost” as its definition of inflation. While another agency, the Bureau of Labor Statistics, uses another definition of inflation: “price.”

What makes this difference so impactful is that different policymakers use different measures of inflation and arrive at markedly distinct recommendations as a result. Let’s look at these two measures of inflation: cost and price.


The Government (BEA) measures costs with something they call Personal Consumption Expenditures (PCE). It is a measure of how much you spend each month on the most common items that you purchase. During times of inflation, like we’re experiencing currently, your “expenditures” rise with the higher cost of goods and services. In other words, this is a measure of the everyday items that you need, things like food, energy, and shelter, plus anything else that you use regularly.

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If you spend 1% more at the supermarket next month, that’s your PCE inflation for food for next month. Because we like to express inflation in annual terms, we need to multiply that by 12(months) to come to a yearly PCE Food Inflation of 12%.

Here’s the rub: since the COVID-19 pandemic, merchants of all kinds have been having nothing but trouble. You’re no doubt aware of all of these, and it’s clear to see in the data. Sales have been all over the place. First came the problem of no customers. In April and November 2020, as well as February 2021, PCE “costs” fell because merchants reduced prices to make sales. In each of those months, PCE “Inflation” fell.

But they fell not because inflation went away but because the customers did. Quarantines, whether imposed by various governments or self-imposed, caused customers to stay out in droves. Consequently, merchants lowered their prices to move inventory. They often sold goods below cost before perishables spoiled or to clear shelf space.

Any policymaker who looked at the “data” in those three months and concluded that inflation was over was sadly mistaken as it came roaring back in the following months. Using Personal Consumption as our chief measure of inflation has added a new dimension: the behavior of the merchant and their customers, as we’ve seen in the last couple of years.


The original measure of inflation is a measure of “price.” Beginning the year the Federal Reserve was founded in 1913, the Minneapolis Branch, along with the Bureau of Labor Statistics, began calculating the changing price of a “basket” of goods. As the price of those goods rose, which was a measure of inflation for the average American, they created the Consumer Price Index (CPI).


It is a highly straightforward inflation calculation, and still today, the most popular. Originally designed as a way for wages and salaries to keep up with rising prices, today, it’s used in contract negotiations and benefits packages as a way for people to keep up with the “cost of living (inflation).”

Ask the average American what the best measure of inflation is, and inevitably, they’ll refer to the CPI. It’s that popular everywhere except Washington DC. That’s right; our leaders don’t use CPI inflation to measure price increases. They use the PCE (Personal Consumption Expenditures) to measure inflation.

Does this PCE group include the Federal Reserve Board, which is responsible for guiding our economy?

Yesterday, the Fed closed the periodic meeting of its interest rate committee (the FOMC). The Committee elected to hold its short-term interest rate (the Fed Funds Rate) steady at 5.5%. They then issued a brief statement. Just four paragraphs long, here is how they ended each section:

Inflation remains elevated.

The Committee remains highly attentive to inflation risks.

The Committee is strongly committed to returning inflation to its 2 percent objective.

The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Get it?

Inflation is the number one driver of the Central Bank’s monetary policy. I don’t recall another Fed that is so focused on one measure of the economy. This group has one drum, and they will beat it as long as it takes to “break” inflation.

But the question is: which inflation are we talking about? Is it PCE Cost-based inflation or CPI Price-based inflation? The answer is that the Federal Reserve uses cost-based PCE Inflation, which is nearly always higher. For instance, in January, cost-based PCE Inflation ran at more than 18% in annualized inflation, which would be very concerning to the Fed. On the other hand, price-based CPI showed that inflation was only slightly more than 6%, or about a third as high as PCE.

PCE Inflation (blue, “cost”), CPI Inflation (Red, “price”)

In the most recent measure of inflation, for September, PCE Inflation was 8.9%, while CPI was half that rate at only 4.75%.

When the Fed selects PCE Inflation, they use a measure of inflation in its most virulent light — making it appear that we have an inflation issue double the CPI level. It will mean they will persist in a tight monetary policy that lasts longer and does more damage than needed under the CPI definition of inflation.

We can count, then, on higher interest rates and Quantitative Tightening that lasts far longer than is needed. It will likely cause far more damage, in terms of reduced economic output, than would otherwise be required.

More Real Money

What’s Inflation? The Fed’s answer to that question makes all the difference, and in this case, it has chosen to fight an “inflation” that is bound to make our lives much more difficult.


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David Reavill

David Reavill writer + finance +iconoclast + hiker + Pennsylvania #valueside daily podcast + medium + meditate valueside.com/links