The Role of Housing in Federal Reserve’s Inflation Measures

The Federal Reserve’s focus on inflation is heavily influenced by housing costs, which contribute significantly to the gap between core CPI and core PCE. Currently, core PCE is at 2.8% while core CPI is at 3.8%, largely due to how each measure accounts for shelter costs. Housing costs make up 43% of core CPI and 17.5% of core PCE, leading to a notable difference in the inflation rates reported by the two indices.

The disparity between these inflation measures has implications for the Fed’s policy decisions, particularly regarding the timing of rate cuts. While the Fed aims for 2% inflation and primarily uses core PCE, the elevated housing costs in core CPI suggest a more urgent need for action to some observers. However, Fed Chair Jerome Powell has emphasized that the Fed is not targeting housing price inflation specifically.

Despite the significant impact of housing costs on inflation measures, the Fed seems relatively unconcerned about the current gap between CPI and PCE. The delay in the impact of lower market rents, along with data collection practices, has kept shelter costs high and inflation elevated. Powell has indicated that the February PCE report aligns with the Fed’s goals, suggesting a patient approach to achieving its inflation target.

While the housing issue is significant, other factors, such as input inflation for manufacturers reaching a two-year high, also influence the Fed’s inflation outlook. These factors could affect the Fed’s ability to return PCE inflation to 2% as planned. Despite these challenges, the Fed remains committed to its inflation goal, though unexpected developments could still impact its plans.