price index is supposed to measure the extent to which the prices of
consumers’ goods change from month to month and year to year. For the whole
lifetime of most people now living, the change in prices, of course, has
virtually always been in the upward direction.
The belief that the index
is a reliable measure of the extent of price increases has led to its
widespread use as a means of adjusting for the effects of inflation. For
example, social security payments are increased every year to allow for
the rise in prices, as is the interest paid on some government bond
issues. In recent years, the income threshold at which taxpayers cross
into higher brackets has also come to be adjusted according to changes in
the consumer price index.
Not surprisingly, as the
party that bears the greatest cost of adjusting payments to reflect the
rise in the consumer price index, the U.S. government has developed a
vested interest in keeping the reported rise in prices as low as possible.
For several years, it has complained that the price index overstates the
rise in prices, and, in the last few years, it has openly taken steps to
modify the price index, in
ways that significantly reduce the reported rise in prices and, of course,
its—the government’s—associated costs.
According to The New
than three years after concluding that the Consumer Price Index overstated
inflation by 1.1 percentage points a year, a group of prominent economists
says changes made to the index since then have narrowed the overstatement
to about eight- tenths of a percentage point a year. . . .
its original report, the Boskin commission said that the overstatement of
inflation in the price index stemmed from a variety of problems. One was
the inability of the index to fully capture decisions by consumers to
switch from one variety of a product to another when prices rise
from Red Delicious to Granny Smith apples, for example.
was the difficulty of accounting for choices by consumers to avoid rising
prices by switching from one type of product to another
video, for example, rather than going out to see a movie.
Apparently, these sources of alleged overstatements in the consumer price
index have now been taken care of, at least to a greater extent than they
were already being taken care of.
But as I think about how
these alleged problems in the price index appear to have been solved, I
cannot avoid coming to the conclusion that what the government and its
Boskin commission have done is use people’s efforts to minimize the
harm they suffer from rising prices to conceal the existence of those
rising prices. That is the only interpretation I can place on the
references to people shifting from one product, or one variety of product,
to another, in order to cope with the rise in prices, and to the
government’s efforts to “capture” those decisions.
I can best explain what
seems to be going on in terms of the following example. Let us imagine
that I live on just two goods: say, steak and potatoes, which I consume in
equal quantities, pound for pound. Steak, we will assume, costs $10 per
pound; potatoes, only $1 per pound. If we wanted to construct a price
index for these two goods, we would have to count the price of steak 10
times as heavily as the price of potatoes, because I spend 10 times more
for steak than for potatoes. Thus, if the price of steak doubled, while
the price of potatoes stayed the same, we would calculate the rise in the
weighted average of these two goods as being in the ratio of $21 to $11,
or about 91 percent.
But now let’s
recalculate the price index according to the government’s
“improvements” in the price index, which seek to account for the
effect of my having to change my pattern of eating in response to the
higher price of steak.
Because the price of steak
has doubled, I can’t afford to buy it any more. I now live entirely on
potatoes, whose price is unchanged. The government reports that now steak
has no weight in my price index. Only the potatoes count, and their price
is unchanged. Voila! There has been no rise in prices—not in the
index that accounts “for choices by consumers to avoid rising prices by
switching from one type of product to another.”
My example, of course, is
highly simplified, but it gets to the heart of something grossly improper
that appears to have been going on in the construction of the consumer
It seems that we may be
getting a consumer price index that in some respects is as devious as some
of the answers given to prosecutors’ questions not so long ago by the
man who presently heads our government. The disturbing question that
arises is whether we can have any more confidence in it than we do in him.
“Economists Readjust Estimate Of Overstatement of Inflation,”
Wednesday, March 1, 2000, p. C14.