“Bought on Behalf” vs. “Purchased by”: What Counts for Inflation?

Inflation, although moderating recently, has been elevated in the U.S. over the past few years. But determining exactly how much inflation Americans have experienced isn’t as straightforward as it might seem.

There are two broad price measures commonly used to measure inflation in the U.S.: the consumer price index (CPI) and the personal consumption expenditures price index (PCEPI). Depending on which measure one uses, prices have increased by either 16% (PCEPI) or 19.3% (CPI) since the start of 2021.Calculations measured from January 2021 through May 2024. This difference is not trivial.

Explaining Inflation Measures

For a sense of scale, consider a worker earning the median salary in 2020—$41,515—in December 2020, who then saw no changes going forward. Adding up the cumulative inflation from January 2021 to May 2024, the worker loses an additional $2,774 of purchasing power if inflation is measured with the CPI rather than the PCEPI.

What explains the indexes’ divergence? Although both measure prices, the PCEPI measures “the prices that people living in the United States, or those buying on their behalf, pay for goods and services,”Emphasis added. while the CPI measures “the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” In this post, we explore how the choice to include or exclude prices for goods and services bought on behalf of consumers affects inflation measures.There are other differences between the two indexes, which are beyond the scope of this post.

Health Care’s Impact on Inflation Measurements

Goods and services bought on behalf of consumers disproportionately come from a few sectors—mainly health care. In 2022, medical goods and services made up about 17% of gross domestic product (GDP) and about 20% of the total personal consumption expenditures (PCE), which forms the basis of the PCEPI.

However, households pay out of pocket for only a small portion of these goods and services relative to those bought on their behalf through Medicare Part A, Medicaid, veterans benefits and employer-sponsored health care plans. The portion of medical spending made on their behalf (almost 70% in 2022, according to the National Health Expenditures Accounts) is included as part of PCEPI, but not CPI.Because out-of-pocket medical expenses paid by consumers are not “bought on behalf” of consumers, these are included in both the CPI and PCEPI. Out-of-pocket expenses made up about 11% of all medical expenses in 2022.

Are consumers affected by price inflation driven from “bought-by-others medical care” in the same way as other components of price inflation? They are not. Employer-paid health care is a form of in-kind payment for labor services the worker supplies to the employer. When the dollar price of an in-kind payment to a worker rises, this reflects not only a nominal increase in the effective cost of the worker’s consumption bundle but also an increase in the nominal compensation—inclusive of the in-kind payment—to the worker.

For Medicare Part A and Medicaid recipients, price increases are felt by the government. Eventually, this may result in reduced coverage for some procedures, greater out-of-pocket expenses or higher payroll taxes for all. However, this part of inflation does not directly affect the recipients’ cost of living.

Both the PCEPI and CPI use weights to summarize across price changes in different consumption categories. The impact of encompassing all health spending—including spending on behalf of consumers—has become more important over the last several decades as the size of the health care sector has grown. That’s because the PCEPI derives its weights for consumption categories based on those categories’ shares of aggregate consumption expenditures.

Analyzing the Difference

The figure below shows how the PCEPI’s and CPI’s respective health care spending weights have changed over time. During the 1960s, health care expenditures made up between 5% and 6% of consumption expenditures. Over the ensuing decades, health care expenditures grew before plateauing at about 20% of consumption expenditures in 2009. This implies that the weight the PCEPI gives to health care expenditures relative to spending on other goods and services has grown by almost 300% over the last 50 years. On the other hand, the CPI’s weight on health spending—which is unaffected by spending on behalf of consumers—has grown much less during the same period, from about 5% to about 8% of the urban consumer’s basket of goods and services.

Health Care Spending Weights over Time: PCEPI and CPI

SOURCES: U.S. Bureau of Economic Analysis, Bureau of Labor Statistics and authors’ calculations.

NOTES: Quarterly data begin in the first quarter of 1960 and end in the first quarter of 2024. The PCEPI weight is imputed.

For each price index, the weights across consumption categories must sum to one. The relatively smaller share for health care in the CPI basket is offset by a relatively larger share for other components, most notably shelter. Shelter has experienced much higher inflation than the health care sector over the past few years. The PCEPI’s upweighting of health care and the associated downweighting of housing helped dampen PCE inflation relative to CPI inflation.

As a back of the envelope calculation, suppose we reduce the PCEPI health care weight from its value of 0.2 to the CPI weight of 0.08 and recalculate an adjusted index. This revised weighting by itself closes one-third of the gap between CPI and PCEPI growth since January 2021.

Notes

1. Calculations measured from January 2021 through May 2024.
2. Emphasis added.
3. There are other differences between the two indexes, which are beyond the scope of this post.
4. Because out-of-pocket medical expenses paid by consumers are not “bought on behalf” of consumers, these are included in both the CPI and PCEPI. Out-of-pocket expenses made up about 11% of all medical expenses in 2022.