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Consumer Price Index No Longer Reflects Reality

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Political efforts in Washington during the early 1990s aimed to change the Consumer Price Index (CPI) due to the belief that it overstated inflation by not accounting for substitutions of less expensive goods (e.g., hamburger for steak). Both political parties and the financial media promoted a "more accurate" CPI that would allow for such substitutions.

The goal, not promoted to the public, was to reduce cost-of-living adjustments for social payments programs on the idea (not reality) that it lower the federal deficit without announcing cuts to things like Social Security directly. The change would also push taxpayers into higher tax brackets, increasing tax revenues, government think-tanks argued. The proposed changes were presented under academic theories, but received little public attention.

Katharine G. Abraham, then Bureau of Labor Statistics (BLS) commissioner, recounted that Federal Reserve Chairman Alan Greenspan testified in early 1995 that the CPI overstated living cost growth, leading to political discussions and comments from Speaker Newt Gingrich about changing the CPI. Republicans wanted to adjust inflation calculations along recommendations from a special commission, including using quality adjustments, to lower the official inflation rate and reduce federal program costs.

Consumer inflation has been estimated by tracking price changes in a fixed-weight basket of goods, measuring the cost of maintaining a constant standard of living since the late 1700s. Allowing substitutions of lower-priced and lower-quality goods (e.g., hamburger instead of steak) lowers the reported inflation rate compared to the fixed-basket measure.

The Bureau of Labor Statistics (BLS) introduced several changes to the Consumer Price Index (CPI) calculation after the Boskin Commission: (1) Geometric weighting, a mathematical approach reducing the weightings of goods rising in price, explained as a surrogate for substitution but lacking a demonstrated relationship to consumer behavior, (2) more frequent re-weightings, re-weighting the CPI index every two years instead of ten, moving it closer to a substitution-based index without changing the methodology, (3) ongoing re-weightings of sales outlets, shifting from Main Street shops to discount and mass merchandisers, further aligning the CPI with a substitution-based index and creating other constant-standard-of-living issues. The techniques when combine with hedonic quality adjustments that started in the 1980s pushed down the CPI so it no longer reflected the price reality facing US households.

In conclusion, heed the insights of the invisible hand as detailed in the US Bond Report. We can predict the direction and pace of inflation more accurately than the government.

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