Comments from The Outpost

13 December 1996

by Dan Murphy

Good evening.

Let's talk about economic magic numbers this week. A group of economists has recommended changing the way we calculate inflation. More specifically, they believe that the CPI -- the Consumer Price Index -- has been overstating inflation for the past few decades, and they have some ideas about how to make it better.

This wouldn't be just an academic exercise either, and the reason is that the CPI is factored into all kinds of different economic calculations that have real effects -- things like income tax rates, social security and other entitlement payments, wage rates specified in union contracts, and so forth. Hence, a change in the way the CPI is figured has the same result as changing ALL the rules about how inflation is adjusted for at the same time.

Since inflation adjustments are often a matter of controversy in contracts and legislation, it's no wonder that various political interests object that this proposal is a way of circumventing the normal debate.

It's kind of like daylight savings time. If we wanted to make everyone get up and run their whole day an hour earlier, it would be nearly impossible to get everyone to just do it. However, by cleverly mandating a change in official time, reflected by setting clocks forward an hour, we cause an entire nation of 200 million people to change the actual time that they do almost everything. And it all happens rather smoothly -- why? Because in our society, we have this almost universal fantasy that clock time MEANS something, and thus an agreement to conform our activities to it.

It's much the same with the CPI and various other metrics that the government or economists calculate and report. This proposal for a change in its factors should remind us that the CPI is, and always has been, a highly arbitrary calculation and a number that means anything only because we choose to give it meaning and because we choose to take actions based on it.

Perhaps we've been giving it too much meaning. Most people are aware that prices don't all inflate at the same rate. Computers and television sets, for example, are cheaper in dollar price than they use to be, and are better besides. On the other hand, you could buy a brand new compact car for about $2000 in the mid 1960's. Compare that with the price of the least expensive new cars today, and you have an example that exceeds the inflation of the CPI substantially. So what does the CPI really mean? As we say, your mileage may vary.

The economists also argue that the current CPI calculation doesn't take account of "substitution" -- that people will switch to chicken if the price of beef goes up, for example. Well, why should it? Maybe some people substitute, and maybe some people choose to continue eating beef. The vernacular for the CPI is the "cost of living", not "the cost of just barely staying alive", so the idea that people can make do with less when some prices rise is exactly what you don't want reflected in the CPI.

Let's keep in mind that the CPI is an arbitrary metric, and as a metric, one of the most important things is that it be determined in the same way every time. This is what allows it to be useful for comparisons and for some understanding of trends. There is no single truth regarding inflation, so changing the CPI doesn't get us nearer to the truth it just creates a different fantasy that's a little more realistic for some people and less so for others.

The real issues here are the results that changing the CPI would have -- things like decreasing governmental outlays for entitlements by a trillion dollars in the next decade or so. It would indeed be a neat trick if that much money could be saved just by changing a few components of a statistical calculation, but it's pretty clear that nobody's falling for it. Powerful political forces, like the AARP, are already gearing up to make sure that their government payments won't be cut by this particular trick. Maybe you can make people get up earlier in the morning by changing the time clocks, but it doesn't look like you can make them accept less social security by changing the inflation clock.

On the other hand, maybe if we set the time clocks back by 50 years or so, a whole host of budget and entitlement problems would go away. Besides that, postcards would be a penny and phone calls would be a nickel.

Somehow, I suspect that people's belief in clock time isn't quite that absolute, and I also suspect that defining the CPI to be lower won't actually make anyone feel better. The CPI is an arbitrary number, but it's OUR arbitrary number. If we want to change how it's used, we need to have the political will to make those decisions directly and abide by the results.

For this week, that's the view from the Outpost. For WMBR, this is Dan Murphy.

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