NCPA - National Center for Policy Analysis

Fixing the CPI: Profound Implications

December 5, 1996

The recommendations of the Congressional Advisory Commission on the Consumer Price Index released yesterday contain vast and far-reaching implications. What might appear as a small bias in the CPI -- which overstates changes in the cost of living by roughly 1.1 percentage points per year -- carries enormous implications when extended over time.
  • Over a dozen years, the cumulative additional national debt from over-indexing the budget would amount to $1 trillion.
  • If this were a separate federal spending program, it would represent the fourth largest program in the budget -- following only Social Security, health care and defense.
  • If inflation is being overstated by 1.1 percent annually, then workers' real hourly earnings rose by 13 percent from 1973 to 1995 -- rather than falling by the same amount as calculated using the uncorrected CPI.

Why does the CPI overstate inflation?

  • The CPI is calculated on the basis of the price of a fixed, representative basket of goods and services over time.
  • However, as consumers respond to price changes and alter their buying patterns as new product choices become available, the "fixed basket" becomes less and less representative.

The CPI uses a fixed market basket of products and prices dating from the 1982 to 1984 period and makes no allowance whatsoever for substitution among commodities. Many new products are brought into the CPI infrequently -- usually at the time of the ten-year revisions.

The Commission recommends that the Bureau of Labor Statistics replace the fixed-weight-index with a cost-of-living index that takes into account consumer substitutions. Other recommendations include allowing the BLS to use scanner data and encouraging it to continually revise its index.

Source: Michael J. Boskin (Chairman, Consumer Price Index Commission), "Prisoners of Faulty Statistics," Wall Street Journal, December 5, 1996.


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