Inflation Is Still Too Low

The consumer price index (CPI) rose slightly less than expected in January, increasing by just 0.2 percent instead of the 0.3 percent gain that economists surveyed by Bloomberg had forecast. Still, prices are 2.9 percent higher than they were 12 months ago. That shouldn’t be confused with the 2 percent inflation target set last month by Federal Reserve Chairman Ben Bernanke. That’s based on the personal consumption expenditures price index (PCE), which tends to increase by about one-third percent less than the CPI.

Bernanke has said that he chose to base the Fed’s inflation target on the PCE because it’s a better reflection of the changes in people’s purchasing habits. One of the big blind spots of the CPI is that it doesn’t capture how people adjust to fluctuating prices by substituting cheap goods and services for those that grew more expensive.