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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
consumer expenditures as part of the measurement of the nation’s gross domestic product (GDP).
The growth rate of traditional price indexes like the CPI, which measure the cost of purchasing a fixed basket of goods and services, tends to outpace cost-of-living indexes, which attempt to calculate the change in expenditure needed to maintain living standards. Concerns have long been expressed that the CPI does not adequately take account of improvements in the quality of consumer goods and services in a technologically dynamic economy and thereby overstates the price increases consumers are paying for goods of constant quality. As a consequence, indexing wages, social security benefits, or other payments scaled to the CPI would usually overstate the amount needed to compensate for increases in the cost of living. Forty years ago, the Stigler Committee outlined the conceptual and measurement characteristics of the CPI that distinguished it from a “true cost-of-living index”—or, under alternative committee labels, a “welfare index,” or a “constant utility” index (National Bureau of Economic Research, 1961). The principal recommendation of the committee was the establishment of a long-run research program designed to make the CPI a better approximation to a cost-of-living index.
In recent years, as the projected long-term financing deficit in the social security system has grown, the question of whether and to what extent the CPI is biased upward, and therefore “overcompensates” social security beneficiaries, has become a concern among some legislators. In 1995 the Senate Finance Committee appointed an Advisory Committee to Study the Consumer Price Index (widely known as the Boskin commission after its chair, Michael Boskin) to review this issue. In its widely publicized final report of December 1996, the Boskin commission concluded that the CPI was currently overstating the rate of increase in consumers’ cost of living by about 1.1 percentage points a year, and it cited estimates from other research pointing to approximately the same result. The commission recommended a number of steps designed to move the CPI away from what was essentially an index of the cost of purchasing a fixed basket of consumer goods toward what would be more nearly a cost-of-living index (COLI).
In 1997 the BLS reported to Congress that it had been using a COLI concept for many years to help make decisions about the CPI and that it accepted a COLI as the measurement objective for the index (Bureau of Labor Statistics, 1997c).1 The report of the Boskin commission, however, undoubtedly spurred BLS to broaden and make more explicit that commitment, and it only recently began taking steps to modify the fixed-weight structure of the CPI so as to bring it closer to a COLI.
The Handbook of Methods (see, for example, the Bureau of Labor Statistics 1984 and 1992 versions) notes that “a unifying conceptual framework for dealing with practical questions that arise in construction of the CPI is provided by the concept of the cost-of-living (COL) index.”