The Federal Reserve raised interest rates Wednesday for the first time since 2006, turning everyone's attention to how quickly subsequent rate hikes will occur. The best way to gauge that will be to track the progress of inflation.
Consumer price increases have been stubbornly slow over the past few years, consistently coming in below the Fed's 2 percent target. Still, Yellen said at a news conference after the meeting that the committee has "reasonable confidence" that inflation will move up with time as the effects of cheap oil and a strong dollar fade. She added that policy makers will need to see those expectations play out as they decide the timing and size of future rate increases.
"We really need to monitor over time actual inflation progress to make sure that it is conforming, it is evolving in the manner that we expect,'' Yellen said, noting that the Fed would be on the lookout for more permanent signs that inflation won't pick up. "Were we to find that the underlying theory is not bearing out," she said, "that would certainly give us pause."
Here are the different gauges that will inform the central bank's outlook and a brief description of what they're telling us.
PCE Price Index
When the Fed formally adopted a 2 percent inflation goal in 2012, officials defined it in terms of the annual change in the personal consumption expenditure (PCE) price index. As you can see below, the measure has made little progress toward the Fed's goal, held back in part by cheap gas and a strong dollar (which makes imports cheaper). The committee expects an acceleration to 1.6 percent next year, based on FOMC meeting materials, but it's nowhere close to that now.
As cheap oil and the strong dollar limit price pressures, the Fed has looked at other gauges to get a better handle on inflation. Officials have repeatedly referenced the core PCE price index, which eliminates the often-volatile food and energy costs. While that measure has tracked higher than the headline index, at 1.3 percent, it's still short of the Fed's goal.
Dallas Fed Trimmed Mean PCE
Several Fed officials—including St. Louis Fed President James Bullard and San Francisco Fed's John Williams—have indicated a preference for the Dallas Fed's trimmed mean inflation gauge. This index is based on the PCE measure, but excludes components that make the biggest moves in either direction. The annual rate is hovering around 1.7 percent by that measure, which is even closer to the Fed's goal.
The consumer price index (CPI) is by far the most affirming gauge for the Fed right now, at least at the core level. Excluding food and energy, the CPI moved up to 2 percent in November from a year earlier, the first time its reached that level since May 2014. CPI has its drawbacks, though: It isn't updated as regularly to reflect consumer spending habits in real time (as is the PCE gauge). That means that when some things get expensive and consumers purchase cheaper products or services instead, the CPI may not be the best measure of inflation.
Note that while the Fed is emphasizing real progress toward its inflation goal, it will also still be looking at price expectations, as noted in Wednesday's Federal Open Market Committee statement.
Fed policy makers, in determining future adjustments to the target range, "will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments," the statement said.