The Fed's PCE Preference and the Trust Game: How Inflation Metrics Shape Policy and Public Perception

The Federal Reserve's preference for the Personal Consumption Expenditures (PCE) price index over the Consumer Price Index (CPI) has long been a subject of debate, but its implications for central bank credibility and inflation expectations are now more critical than ever. As the Fed navigates a post-pandemic economy marked by stubborn inflation and shifting public sentiment, its reliance on PCE—a broader, more flexible metric—has both strengthened and strained its policy effectiveness.

Why PCE? A Technical Preference with Macroeconomic Logic

The Fed's choice of PCE as its primary inflation gauge is rooted in its methodological advantages. Unlike the CPI, which focuses narrowly on out-of-pocket expenses for urban consumers and uses a fixed basket of goods, the PCE incorporates a broader range of expenditures, including those made on behalf of households by third parties (e.g., employer-sponsored health insurance, Medicare/Medicaid benefits) The Fed's Preferred Inflation Gauge: Why PCE Matters More Than CPI [https://govfacts.org/explainer/the-feds-preferred-inflation-gauge-why-pce-matters-more-than-cpi/]^[1]. This makes PCE a more comprehensive reflection of total consumer spending, which accounts for roughly two-thirds of U.S. GDP The Fed - Inflation (PCE) - Federal Reserve Board [https://www.federalreserve.gov/economy-at-a-glance-inflation-pce.htm]^[2].

Moreover, PCE employs a chained index formula that accounts for consumer substitution behavior. For example, if the price of chicken rises, consumers may shift to beef or pork, and PCE captures this real-world adjustment, whereas the CPI's fixed basket does not Why Does the Fed Prefer PCE Over CPI? - Kiplinger [https://www.kiplinger.com/investing/economy/why-does-the-fed-prefer-pce-over-cpi]^[3]. This flexibility results in smoother, less volatile inflation readings, which align with the Fed's dual mandate of promoting price stability and maximum employment PCE vs CPI: Fed's Inflation Gauge Explained - svb.com [https://www.svb.com/market-insights/market-analysis/economic-vista-to-PCE-or-not-to-PCE/]^[4]. By integrating PCE with GDP calculations, the Fed gains a clearer signal of underlying inflation trends, enabling it to avoid overreacting to temporary price shocks, such as those caused by supply-side disruptions The Federal Reserve's Tightrope Walk: Rate Cut Amidst Stubborn Inflation Tests Dual Mandate [https://markets.financialcontent.com/wedbush/article/marketminute-2025-9-18-the-federal-reserves-tightrope-walk-rate-cut-amidst-stubborn-inflation-tests-dual-mandate]^[5].

The Policy Effectiveness Paradox

While PCE's technical merits are undeniable, its use has created a paradox for monetary policy. On one hand, the Fed's focus on PCE allows it to make more informed, long-term decisions. For instance, core PCE inflation has remained relatively stable at 2.8–2.9% since 2023, while core CPI frequently exceeded 3.5% during the same period Two Measures of Inflation: April 2025 - Advisor Perspectives [https://www.advisorperspectives.com/dshort/updates/CPI-PCE-Comparison]^[6]. This divergence has led the Fed to maintain a cautious stance on rate hikes, even as headline CPI inflation spiked in 2022 due to energy and food price surges June 18, 2025: FOMC Projections materials, accessible version [https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20250618.htm]^[7].

On the other hand, this approach risks a disconnect between the Fed's policy actions and public perception. The CPI, which is released earlier and more frequently referenced in media and financial markets, often reflects the immediate cost-of-living pressures faced by households Why the Fed Prefers PCE Over CPI for Inflation Insights [https://www.cmegroup.com/openmarkets/equity-index/2025/Why-the-Fed-Prefers-PCE-Over-CPI-for-Inflation-Insights.html]^[8]. When gas prices or grocery bills spike, the public feels the impact acutely, even if core PCE remains within the Fed's 2% target range The Fed's Preferred Inflation Gauge: Why PCE Matters More Than CPI [https://govfacts.org/explainer/the-feds-preferred-inflation-gauge-why-pce-matters-more-than-cpi/]^[9]. This mismatch has fueled skepticism about the Fed's ability to manage inflation, particularly during periods of high volatility.

Central Bank Credibility and the Trust Gap

Central bank credibility hinges on the alignment between policy actions and public expectations. The Fed's preference for PCE has inadvertently widened the trust gap between policymakers and the public. A 2025 study using AI-driven sentiment analysis of social media found that public trust in the Fed fluctuated sharply during the 2020–2021 inflation surge, with trust declining as CPI inflation outpaced PCE readings A new measure of trust in central banking | CEPR [https://cepr.org/voxeu/columns/new-measure-trust-central-banking]^[10]. This erosion of trust is compounded by the fact that CPI is used to adjust Social Security payments and as a benchmark for Treasury Inflation-Protected Securities (TIPS), making it more directly relevant to everyday financial planning PCE vs. CPI: The Two Faces of U.S. Inflation | GovFacts [https://govfacts.org/explainer/pce-vs-cpi-the-two-faces-of-u-s-inflation/]^[11].

Furthermore, the Fed's communication strategy has struggled to bridge this gap. While officials emphasize PCE's advantages in press conferences and FOMC statements, the public often interprets these explanations as dismissive of their lived experiences. This disconnect undermines the anchoring of inflation expectations—a critical component of the Fed's credibility. If households believe the Fed is out of touch with their economic realities, they may anticipate higher inflation persisting, which can become a self-fulfilling prophecy The Anchoring of US Inflation Expectations Since 2012 [https://www.clevelandfed.org/publications/economic-commentary/2023/ec-202311-the-anchoring-of-us-inflation-expectations-since-2012]^[12].

The Path Forward: Balancing Technical Precision with Public Trust

The Fed faces a delicate balancing act. On one side, PCE's technical superiority ensures that policy decisions are grounded in a stable, macroeconomic framework. On the other, the public's reliance on CPI necessitates clearer communication about the rationale for PCE and how it aligns with broader economic goals.

One potential solution lies in enhancing transparency. The Fed could publish more detailed comparisons between PCE and CPI, explaining how each metric reflects different aspects of inflation. For example, highlighting that PCE includes employer-paid healthcare costs—now a significant portion of household expenses—could help the public understand why PCE readings differ from their own experiences Measuring Inflation Using CPI vs. PCE – by Dr. Cecil Bohanon and Dr. John Horowitz [https://people.bsu.edu/econbriefs/2025/05/07/measuring-inflation-using-cpi-vs-pce-by-dr-cecil-bohanon-and-dr-john-horowitz/]^[13].

Additionally, the Fed must address the anchoring of inflation expectations. Recent research indicates that medium-term expectations have weakened, suggesting that households are less confident in the Fed's ability to return inflation to 2% The Federal Reserve's Tightrope Walk: Rate Cut Amidst Stubborn Inflation Tests Dual Mandate [https://markets.financialcontent.com/wedbush/article/marketminute-2025-9-18-the-federal-reserves-tightrope-walk-rate-cut-amidst-stubborn-inflation-tests-dual-mandate]^[14]. By reinforcing its commitment to price stability through consistent messaging and data-driven policy adjustments, the Fed can rebuild trust and ensure that expectations remain well-anchored.

Conclusion

The Fed's preference for PCE over CPI is a technical necessity for macroeconomic analysis, but it carries significant risks for central bank credibility. As inflation expectations and public trust become increasingly intertwined with policy outcomes, the Fed must navigate the tension between precision and perception. By bridging the gap between PCE and CPI through improved communication and transparency, the Fed can uphold its dual mandate while maintaining the trust of the public it serves.