Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / Why the CPI Drop Doesn't Match Your Grocery Cart
Transcript
- Lucas: So the June CPI came in at 3.5 percent year-over-year, down from 3.8 percent in May. Headline number looks like good news. But I keep hearing from people — colleagues, neighbours, the person in front of me at the deli counter — who say, 'My grocery bill hasn't gotten any cheaper.' And they're not wrong. Luna: Right, because the CPI basket assumes you change what you buy when prices shift. The classic example: if beef gets expensive, the model says you buy chicken instead. But what if you don't eat chicken? Lucas: Exactly. That's the substitution bias baked into the CPI. The Bureau of Labor Statistics updates the basket every two years, but in between, they apply a formula that essentially assumes you swap to the cheaper option. If you keep buying beef, your personal inflation rate is higher than the official number. Luna: And that's not even touching quality adjustment. A cereal box that shrinks from 20 ounces to 16 ounces at the same price — the CPI treats that as no price increase because the per-ounce cost is adjusted downward. But you're still paying the same for less. Lucas: Right, shrinkflation is real, and the CPI's methodology tries to account for it by estimating the per-unit price. But the way they do it — hedonic quality adjustment — can get pretty abstract. They might decide that a slightly slower processor in a laptop is a 'quality improvement' for the new model, even if you'd rather have the faster one. Luna: So the CPI is telling us inflation is cooling, but the PCE price index — the Fed's preferred gauge — actually ticked up in May, to 2.6 percent annualized. Why the divergence? Lucas: Great question. The PCE covers a broader scope of spending — including things like employer-provided health insurance and financial services — and it weights things differently. It also accounts for substitution more frequently than the CPI does. So when energy prices dropped in June, the CPI felt that more sharply than the PCE did. Luna: But the PCE still misses the pain of everyday purchases the same way. My rent went up six percent last year. The shelter component of both indexes is still lagging. Lucas: Shelter is a whole separate conversation — we did an episode on that. But to come back to the grocery cart: the June CPI food index rose 0.2 percent month over month. That's modest. But within that, meats, poultry, fish, and eggs rose 0.6 percent. Cereals and bakery products rose 0.4 percent. If those are the categories you buy most, you're not seeing the headline easing. Luna: So when we hear 'inflation is down to 3.5 percent,' we need to ask: which 3.5 percent? The one that assumes I switch to store-brand cereal and cheaper cuts of meat? Lucas: Precisely. And the Bureau of Labor Statistics does a great job being transparent about this — they publish the detailed expenditure weights and the substitution assumptions. But most people don't read the methodology appendix. They just see the headline. Luna: And then they feel gaslit. Lucas: Yeah. So here's one concrete thing to watch next month: look at the 'CPI for All Urban Consumers' versus the 'Chained CPI.' The chained version accounts for substitution in real time. In June, the chained CPI rose 3.2 percent — lower than the regular 3.5 percent. That gap — three-tenths of a point — is a rough measure of how much substitution the government assumes you're doing. Luna: And if you're not substituting, your personal rate is closer to the regular CPI. Or higher. Lucas: Right. And that's why the disconnect persists. The Fed watches the PCE, which is even more substitution-friendly than the chained CPI. So the central bank sees inflation around 2.6 percent, thinks 'we're almost there,' while a lot of households are still seeing 4 or 5 percent. Luna: So the policy response — holding rates at 3.63 percent or cutting — is based on a reality that doesn't match the lived experience for many. Lucas: Exactly. And look, the Fed knows this. Chair Powell has said several times that they look at a broad range of data. But the official target is PCE at 2 percent. And we're above that, but closer than the CPI suggests. Luna: So what do we do as listeners? How do we make sense of the numbers without getting a PhD in index methodology? Lucas: I think the most practical thing is to track your own 'basket.' Pick five to ten items you buy regularly — milk, bread, gas, rent, a streaming subscription — and note the price once a month. Compare that to the CPI for those categories. You'll quickly see where you diverge. Luna: That's actually a great exercise. And it might also help you decide where to cut back or shop around. Lucas: And if that exercise has made today's conversation worth a coffee to you — if walking through the economy with us has made something click — honestly, that's the link: buy me a coffee dot com slash fexingo. It takes two minutes, and it keeps this show ad-free and independent. Luna: Yeah, it really does. We don't have sponsors, so listener support is what keeps us going. And it's the smallest ask — the price of a coffee, literally. Lucas: So back to the data: the ten-year breakeven inflation rate, which is the market's expectation for average inflation over the next decade, is at 2.26 percent. That's up slightly from last week. So bond traders are pricing in inflation that stays above the Fed's target for years. Luna: Meaning the market doesn't believe the Fed will get back to 2 percent anytime soon. Lucas: Right. And that's consistent with the idea that the CPI and PCE are telling different stories. The market sees persistent inflation in services and shelter, and doesn't think the recent goods deflation will last. Luna: So the next CPI release — July data comes out in August — will be key. If we see another drop in headline, but the chained CPI holds steady, the disconnect widens. Lucas: Exactly. And that's when the Fed has a real communication challenge. Do they cut rates because headline is falling, or hold because households are still feeling the squeeze? I think they'll hold until they see consistent improvement in both the CPI and the PCE, and until the breakeven rate drops closer to 2. Luna: So the takeaway for today: when you see a headline about inflation dropping, check the details. Look at the chained CPI, look at the PCE, and compare it to your own spending. The number that matters most is the one that affects your wallet. Lucas: And if you want to do that comparison with us next month, we'll be here. Thanks for listening, and we'll see you next time.