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At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes
that public policy seeks to tie benefits to changes in the cost of living, a number of choices still remain about whether the present CPI (together with changes that are planned for the near future) or some alternative version is the appropriate one—for example, a separate index for the elderly.
Using a Lagged Superlative Index for Escalation
We conclude that, for adjusting benefits to keep pace with the cost of living, the superlative index, which the BLS will begin to publish in 2002, will be the appropriate one to use. But that index will be available only after a 2-year delay. One way to deal with this lag would be to pay an initial cost-of-living adjustment based on the change in the fixed-weight CPI and then incorporate a correction 2 years later based on the lagged superlative. Thus, the cost-of-living adjustment (COLA) for 2004 would increase the benefit payment by the change in the regular fixed-weight CPI for the past year minus a correction for the difference between the regular CPI for 2002 and the superlative index for that year, which would just have been published. If recent history is a guide, the superlative index will show an average increase of about 0.1 to 0.2 percent a year less than the real-time CPI, with a range of 0.0 to 0.5 percentage points (Aizcorbe and Jackman, 1993; Shapiro and Wilcox, 1997). A small initial “claw back” would be required; thereafter, the COLA would tend to be very close to the change shown by the current year’s real-time CPI minus an adjustment that typically fluctuated within a narrow range.
There is an alternative that may offer some advantages and which the recommendation below would facilitate:
Recommendation 7-1: The BLS should publish, contemporaneous with the real-time CPI, an advance estimate of the superlative index, utilizing either a constant-elasticity-of-substitution method or some other technique.
There are several possible ways to construct that estimate. Individual researchers have constructed estimates of the superlative using only reference-period weights and a constant-elasticity-of-substitution formula, whose major parameter was estimated from a comparison of the real-time CPI with the superlative in prior years. Such estimates, when tested over short periods of time, have very closely tracked the superlative that later became available, although particular patterns of substantial changes in relative prices could produce larger divergences. Alternatively, the BLS could utilize other techniques for making an advance estimate, perhaps taking advantage of the latest information on relative price changes in the real-time CPI.
For purposes of escalation, the panel arrived at the following:
Conclusion 7-1: It would be feasible and appropriate to calculate cost-of-living allowances provided for social security and other pro-