Advancing a Free Society

Reforming CPI: Not a “Grand Bargain” but a prudent reform

Tuesday, July 12, 2011

Recent reports indicate that the budget/debt negotiations will not produce a “grand bargain.” At best they will produce a smaller set of targeted reforms slightly improving but not correcting the unsustainable trajectory of federal finances. But whether the budget discussions produce a big deal or a small one, however, both sides would do well to implement a more accurate measure of economy-wide inflation, namely the “chained” C-CPI-U.

Basic background: Many aspects of federal law from income tax brackets to Social Security payments are indexed to grow each year with price inflation, more specifically with the Consumer Price Index (CPI). There are different versions of CPI now in use, including the CPI-U (measuring inflation facing all urban consumers) and the CPI-W (measuring inflation facing urban workers). Some programs use one of these and some the other, but generally the two are close in value anyway.

Over the years, many economists have noted that these measures tend to overstate actual price inflation as felt by consumers. Simplifying considerably, this is because the rising price of one item often causes consumers to buy a different item instead, one whose price hasn’t risen as much. The mix of items that consumers buy thus changes over time, with the increase in the total cost of living being less than if no purchase substitutions had occurred.

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