The consumer 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 York Times:
More 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. . . .
In 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.
Another was the difficulty of accounting for choices by consumers to avoid rising prices by switching from one type of product to another – renting a video, for example, rather than going out to see a movie.[1]
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 price index.
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.
Notes
[1] The New York Times, “Economists Readjust Estimate Of Overstatement of Inflation,” Wednesday, March 1, 2000, p. C14.
To learn about every aspect of the case for capitalism, read my Capitalism: A Treatise on Economics. Originally published at the blog of George Reisman. Copyright 2019 George Reisman. All rights reserved.
