The Medical Care Component of Personal Consumption Expenditure Price Index - Flavor of the Week

By: Paul Kasriel | Mon, Feb 26, 2007
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Among the several economic reports due for publication this week -- new home sales, existing home sales, consumer confidence measures, durable goods orders, preliminary estimate of fourth quarter real GDP, and ISM manufacturing survey results for February, construction outlays for January, and the personal income and outlays report for January-- the Fed's preferred inflation measure will garner a great deal of attention. The core personal consumption expenditure (PCE) price index, which excludes food and energy, advanced 2.22% in December, representing a deceleration from the 2.44% peak seen in August. This improvement is important because core inflation is heading in the direction of the FOMC's comfort zone of 1%-2%. However, after the January Consumer Price Index (CPI) was reported, there were concerns about the January core PCE price index because it is largely based on the CPI.

The main reason for the anxiety is the fact that the sharp 0.8% increase in medical care prices was responsible for 60% of the increase in the core CPI. Although the PCE price is based on the CPI but there are several differences in terms of scope and weights of components. Medical care expenses (weight was 17.1% in 2006) in the PCE price index are roughly three times the weight of medical care in CPI (weight is 6.28% in 2007 ). The inputs used for the medical care component of the PCE price index are broader in scope compared with the medical care price index in the CPI and part of the medical care price information is obtained from the Producer Price Index. Historically, the year-to-year change in the two price indexes show a strong positive correlation (see chart 1)

Chart 1

However, in recent years, the two price indexes have diverged and their movement is not as close as seen previously.

Chart 2

Therefore, it is not clear, if the core PCE index of January (scheduled to be published on March 1) will show a large increase as implied by the core CPI. Chart 2 shows that medical care prices are advancing at a faster pace in the CPI compared with the PCE.



Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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