Getting the Prices Right
by David Morris
December 17, 1996
Never before has so bad an idea so quickly captured the imagination of America’s leadership. I’m talking, of course, of the preposterous notion of reducing inflation by congressional fiat.
This nonsense began in January 1995 when Federal Reserve Chairman Alan Greenspan informed an enchanted Congress that the federal government could eliminate the budget deficit simply by reducing the consumer price index(CPI) by one percentage point. One third of the federal budget is linked to the CPI in some way. Greenspan insisted that the CPI consistently overstates the inflation rate.
Within a few days the irrepressible House Speaker Newt Gingrich jumped on the bandwagon with a vengeance, vowing that unless the BLS could “get it right” within 30 days, he would wipe out the bureau’s CPI staff.
The Senate Finance Committee took a kinder and gentler approach. It appointed a task force of five well-known economists, four of whom were already on the public record as believing the CPI overstates inflation. Their task was not to decide whether the CPI overstates the inflation rate, but by how much. Earlier this month the study group, chaired by Michael Boskin of Stanford University, completed its mission by arriving at a number: 1.1 percent.
The political leadership is rallying around Boskin’s numbers. But there is a fundamental problem here. As Professor Dan Mitchell of the Anderson Graduate School of Management at UCLA observes, ÒPeople have an enormous vested interest in saying that the CPI has an upward bias…No one has an interest in saying that it understates inflation. But in some ways, it probably does.Ó
It is unsurprising yet revealing that Boskin’s distinguished colleagues could not identify a single instance where the CPI understates the inflation rate. Offhand, I can think of several instances. The CPI does not take into account federal or state income taxes or social security taxes. Social security taxes have doubled in the last 15 years. Most increase in health insurance premiums are not picked up as price increases by the CPI. This is particularly important in measuring the rate of inflation experienced by the elderly as both Democrats and Republicans propose increasing the Medicare tab picked up by seniors.
The Boskin Commission concluded that for many goods and services the CPI doesn’t take into account quality improvements. But several economists make the opposite case. Consider how the CPI treats cars. If the cost of a car goes up by $400 because it has an airbag the CPI assumes the cost didn’t increase at all because this is a quality improvement. The change in the price index for new cars would have been 80 percent greater 1967 to 1994 if no adjustments had been made for quality improvements.
As economic researcher Tony Riley points out, in 1980 the average family had to work 19 weeks to buy a new car. In 1995 they had to work 28 weeks. I call that serious inflation. The CPI doesn’t.
Politicians see Boskin’s recommendations as painless way, at least from their perspective, to eliminate the deficit. The irony is that if Boskin is correct, the case for eliminating the budget deficit virtually disappears. Here’s why. If we assume the CPI has been grossly overstating inflation for the past two decades, then we must also assume that the federal government has been grossly understating increases in productivity or real income or economic growth. If we were to apply Boskin’s recommendations retroactively back to 1970 we would find that living standards, contrary to widespread belief, have been soaring. In short, as Dean Baker of the Economic Policy Institute explains, if Boskin is right the era of deficit spending has been the golden age of America. Congress seems to be saying, “Give me the cash and don’t bother me with the policy implications”.
Here’s where I stand. If Congress wants to eliminate the deficit by taking $100 a year from everyone’s pocket, rich or poor, let them have the political courage to stand up and vote to do so. But don’t order the BLS to fudge the numbers. Doing so constitutes not only an act of political cowardice but a step that could plunge the difficult science of inflation analysis into chaos.
Seven hundred inflation monitoring statisticians at the Bureau of Labor Statistics(BLS) examine 90,000 items each month. Many of the world’s leading price theorists work in the Bureau. The CPI is not a static index. Over the years the BLS has made major refinements in its analytical methodologies. Measuring inflation is a horrendously complicated and often controversial field. It is best left to the professionals.
David Morris is vice-president of the Institute for Local Self-Reliance