February 21, 2002
Labor Department to Publish
New Measure Will Address Concerns
That the CPI Is Overstating Inflation
By GREG IP
WASHINGTON -- The Labor Department will publish a new consumer price index beginning this summer to address some longstanding concerns that the current index overstates inflation.
The new measure, called a "superlative" or "chain" consumer price index, is meant to better capture how consumers tend to shift purchases to products whose prices are falling in relative terms. It will supplement, but not replace, the current CPI, the most widely used measure of how a household's cost of living changes over time, the Labor Department said Wednesday. Bureau of Labor Statistics research suggests annual inflation would be 0.1 to 0.2 percentage point lower measured with the new index.
Many academics and some policy makers, such as Federal Reserve Chairman Alan Greenspan, have argued that the CPI overstates the change in the cost of living for several reasons. The reasons include inadequate adjustment for improved quality, the introduction of new products, the trend toward lower-price stores and the tendency to buy more of products that are getting cheaper, and less of those getting more expensive.
The new chain CPI, which the Bureau of Labor Statistics will begin publishing with July's data in August, addresses this last factor, so-called substitution bias.
For example, if the price of cigarettes rose sharply between 1998 and 2002 while the price of cellphone services fell, people in 2002 would probably smoke less and talk more on their cellphones. Using a 1998 "basket" of goods and services -- an estimate of how a typical household spends its budget -- would overstate the significance of rising cigarette prices and understate the significance of falling cellular charges in 2002, thus overstating inflation. The new index employs a formula to adjust for the change in spending weights.
CPI measurement has been a hot political topic in the past because it is used by the government to index things like Social Security benefits and income-tax brackets, and is also widely used in private contracts, such as union agreements, for cost-of-living adjustment clauses. In 1996, a commission headed by Michael Boskin, chairman of the Council of Economic Advisers under the first President Bush, concluded that the CPI overstated inflation by 1.1 percentage points a year. Among other recommendations, the commission urged that the CPI be modified to correct for substitution bias.
Despite its analytical advantages, the new CPI might not be a suitable replacement for the regular CPI for contractual cost-of-living calculations. Because of the lags in obtaining updated expenditure weights, the chain CPI will be revised regularly, a fact that would complicate contracts. The regular CPI is never revised, except for seasonal-adjustment factors. There might also be political difficulties. The Social Security Administration by law must index benefits using the current CPI.
At present, even the regular CPI suggests inflation pressure is dormant. The Labor Department said Wednesday that the index rose 0.2% in January from December as rising gasoline prices were offset by drops in clothing costs. Excluding the volatile food and energy components, the so-called core CPI was also up just 0.2%.
But in the next year or two, as the economy recovers and concerns rise over a return of inflationary pressure that could force the Federal Reserve to raise interest rates, measurement issues will become more significant.
The BLS has modified the CPI since the Boskin commission issued its report. A study last year by Federal Reserve Board researchers David Lebow and Jeremy Rudd concluded that the CPI now overstated the annual change in the cost of living by a lesser, though still significant, 0.6 percentage point, with half of that due to inadequately capturing improved quality and new products.
Fed officials already prefer to measure inflation with the so-called index of personal consumption expenditures, or PCE, rather than the CPI. The PCE index is used by the Commerce Department to calculate the gross domestic product and its weights are continuously updated and are based on a different, and possibly more accurate, survey of consumption. Last year, the PCE index rose just 1.9% from 2000, compared with 2.8% for the CPI. That is one reason Fed policy makers, in their public comments, have been relatively sanguine in recent months on the inflation outlook.
Write to Greg Ip at firstname.lastname@example.org
Updated February 21, 2002
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