from the Cleveland Fed

The gap between two well-known measures of inflation – the year-over-year percent change in the core Consumer Price Index (CPI) and the core Personal Consumption Expenditures (PCE) price index – has widened recently to a level not seen since the last recession.

Figure 1. Change in Core CPI and Core PCE Indexes

One potential explanation for this widening spread between the core indexes is low healthcare inflation and the fact that healthcare is treated differently in each index. Each core index can be roughly thought of as a weighted average of the price growth of components in a basket of goods and services. Healthcare receives the largest weight of all the basket components in the calculation of core PCE inflation (about 25 percent) but is weighted at just 10 percent in the core CPI. This is because the CPI only takes out-of-pocket consumer healthcare expenditures into account, while the PCE augments these with purchases that have been made on behalf of consumers by employer-provided insurance, Medicare, and Medicaid. Given this significant weight differential, it is conceivable that low healthcare inflation could be pushing year-over-year core PCE growth well below the rate of core CPI growth.

To investigate this possibility, we construct a composite price index that we can use to measure overall healthcare inflation. We calculate this index in the same way as the core PCE index, but use only the medical goods and services components of the core PCE basket (see Dolmas 2005 for more details). This healthcare index shows that since 2012, and especially since mid-2014, healthcare inflation has been approximately the same as core PCE inflation. Prior to then, healthcare inflation consistently exceeded core PCE inflation.

Next, we construct a second index by stripping healthcare goods and services from the core PCE index. Comparing the year-over-year growth in this index to core PCE allows us to see the contribution of healthcare inflation to core PCE inflation over time. Healthcare inflation pushed up core PCE inflation an average of 40 basis points from 2000 to 2007. However, it has had a relatively neutral effect following the shock of the Great Recession, contributing an average of zero basis points to core PCE inflation from 2011 onwards.

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