At What Price? Conceptualizing and Measuring Cost-of-Living and Price Indexes (2002) / Chapter Skim
Currently Skimming:
7 Index Design and Index Purpose
7 Index Design and Index Purpose
Pages 191-221
The Chapter Skim interface presents what we've algorithmically identified as the most significant single chunk of text within every page in the chapter.
Select key terms on the right to highlight them within pages of the chapter.
From page 191... ...
to produce a lagged superlative index in addition to the "flagship" Consumer Price Index (CPI) ; we also suggest publication of an advance forecast of the superlative for compensation purposes (see below and Chapter 2~.
|
From page 192... ...
INDEXING PUBLIC TRANSFER PAYMENTS The CPI is widely used within government and among private parties as a means of maintaining the purchasing power of a flow of transfer payments in the face of changes in prices, sometimes specifically identified as changes in the cost of living. In a similar vein, the CPI is used to adjust eligibility limits for certain kinds of payments, usually to the poor, that were initially set in nominal dollar terms.
|
From page 193... ...
Adjusting Social Security Benefits The most prominent public policy use of the CPI is for indexing benefits paid to social security retirees. Prior to 1972 Congress had periodically legislated increases in social security benefits, usually by more than enough to cover changes in inflation (as measured by the CPI)
|
From page 194... ...
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
|
From page 195... ...
Compensating Beneficiaries Who Have Other Income Many social security retirees have other income, in some cases substantially exceeding their social security benefits. The broad objective of Congress in providing a cost-of-living adjustment was and is to protect the social security income of beneficiaries, and not their other income, against the consequences of price changes.
|
From page 196... ...
What are the implications of tying social security payments to a tax-andprice index rather than the current expenditure-based index, assuming that a single overall CPI would continue to be used for indexing purposes? First, social security retirees pay no payroll taxes; and in the federal and many state income tax systems social security benefits are more lightly taxed than other forms of income, at least for low- and lower-middle-income taxpayers.
|
From page 197... ...
The CPI-U Versus the CPI-W for Indexing Transfer Payments In 1978 the CPI was revised in a major way, including an expansion of its coverage from "urban wage earners and clerical workers" (one-third of the population) to "all urban consumers" (four-fifths of the population)
|
From page 198... ...
And since, in the construction of measures of national output, the individual strata indexes of the CPI are used to deflate most of the components of consumption expenditures, a plutocratic version of those individual indexes is needed. But for purposes of indexing social security benefits and other public transfer payments and for dealing with economic welfare considerations generally, a democratically constructed index seems clearly preferable since it assigns the preferences of each household equal importance.
|
From page 199... ...
The retiree receives protection against inflation and is insured against the economic vicissitudes that can erode the real wages and living standards of the working population such as a large surge in energy prices or a major depreciation of the real exchange rate. With wage indexing, a worker or retiree gives up those protections but gains the advantage of sharing in the fruits of future national productivity growth and any other economic developments that improve real wages.
|
From page 200... ...
In implementing wage indexation, Congress might well decide that the same measure used to index preretirement wages for calculating the initial benefit ought simply to be extended through the retirement years, as the index for maintaining the relationship between postretirement benefits and the real wages of the working population. However, this choice is not the only one for which a reasonable argument might be advanced.
|
From page 201... ...
A second question concerns the scope of a wage index: Should it measure changes in the overall compensation of workers, including not only wages but fringe benefits, or should it cover wages only? Over most of the past 50 years, fringe benefits chiefly, employer-paid pensions and health insurance costsrose more rapidly than wages, so that the growth in real compensation per hour exceeded the growth in wages by about 0.25 percent a year.
|
From page 202... ...
Over the past twenty years rising earnings inequality kept median wage growth close to zero. And, on average over those years, ECI compensation growth exceeded ECI wage growth as fringe benefits rose more rapidly than wages during most of the penod.
|
From page 203... ...
With respect to payroll taxes, social security has always been, and still is, mainly a pay-as-you-go 1OIn addition, if the indexing instrument is a mean wage measure, any additional benefits that retirees received through the effect of rising inequality in raising the mean relative to the median wage would sooner or later in a pay-as-you-go system have to be paid for by payroll taxes, which, taken by themselves, bear disproportionately on lower-income workers. Indexing social security benefits to a measure of mean wages during periods of rising inequality would, albeit in a modest way, accentuate the effects of the rising wage inequality.
|
From page 204... ...
social security system has for many years based both the payroll taxes that support it and the calculation of initial benefits on money wages, excluding the value of fringe benefits. It would seem anomalous to leave these aspects of the system unchanged while tying benefits in the years after retirement to a wage index that includes fringe benefits.
|
From page 205... ...
Should long-term productivity growth and the trend toward wage inequality revert to 1973-1995 patterns while a median wage measure was used for indexation, the switch to wage indexing would provide benefit adjustments that, on average over the years, would be unlikely to differ very much from those derived by CPI indexation. However, while far from certain, the odds seem a good bit better than even that over the long term the real wages of the median American worker will see some rise.
|
From page 206... ...
An alternative approach would be to subtract from the annual growth of the wage index a legislatively fixed amount that would keep the present value of the time path of benefits equal to what it would have been under price indexing, again using the real-wage growth projected in the Trustees' report at the time of the switch. This approach would preserve many of the basic characteristics of wage indexing without adding to the projected cost of the system.
|
From page 207... ...
Should multiyear wage contracts with escalator clauses become more prevalent, giving substantial advance notice of methodological changes and, where feasible, publishing the "old" indexes during a transition period would take on added importance. On an informal basis, the rate of inflation as measured by the CPI is one factor among many influencing the setting of nominal wages, through its effect on some combination of adaptive and "rational" expectations about the shortterm prospects for changes in prices and the cost of living.
|
From page 208... ...
(For simplicity we assume here that the insurance protects the seller, or the 14See below for a discussion of the effect of CPI methodological revisions on macroeconomic policy. 15If workers and employers should continue to set nominal wages as if downward revisions had not occurred while the central bank lowered the target inflation rate, the rate of unemployment consistent with full employment could rise.
|
From page 209... ...
In that case the seller bears the "basis" risk of unforeseen relative price changes in the particular goods that are relevant to his costs but is protected against the common component of price changes manifest in inflation. For purposes of inflation protection, the usefulness of the CPI, which covers only final consumption goods and services, has to be evaluated against that of available alternatives: the GDP price index, which covers all final goods and services, and the finished goods producer price index (PPI)
|
From page 210... ...
To the extent that private parties to indexed contracts have provided for arbitration or other procedures to resolve disputes when significant revisions occur in index design, the availability of such research series could aid the parties in making appropriate adjustments.l7 If the research that precedes a change in index measurement makes it possible to produce estimates of the effect of the changeprior to its introduction into the index, this information can give both parties about to enter into an indexed contract notice of what is likely to occur. Along this line, BLS made available the results of its experimental geomeans research before the technique was introduced into the CPI, and the BEA published its Fisher chain price indexes for 5 years before substituting them for the old fixed-weight indexes.
|
From page 211... ...
The interest rate is fixed for the term of the security, and interest is paid semiannually on the inflation-adjusted principal. Both interest payments and any adjustment to the principal are subject to federal income tax in the year they occur, but they are exempt from state and local taxes.
|
From page 212... ...
Any unavoidable costs associated with creation of a risk premium in TIPS are likely to be much smaller than the benefits to society from an improved index in its many uses. INDEXING THE FEDERAL INCOME TAX SYSTEM In the federal income tax system, marginal tax rates rise with nominal income.
|
From page 213... ...
It takes into account the effects on the ratio of taxes to direct consumption costs arising from the factors listed above, the most important of which have been the indirect effects of changes in federal payroll tax rates. The formula also requires the construction of individual indexes for every consumer in a subsample of the 1973 Consumer Expenditure Survey in order to mimic the effect of the progressive federal income tax system.
|
From page 214... ...
or, correspondingly, constant dollar output measures. In this context an aggregate index of inflation ought to be evaluated in terms of its ability to partition expenditures into two symmetric components an index of inflation and an index of output change, which when multiplied together produce the observed change in current dollar expenditures.21 In the United States, as in most other industrial countries, the overall CPI or its equivalent is not used as a deflator for aggregate consumption expenditures, but its individual components are the deflators for most of the individual categories of consumption expenditures.
|
From page 215... ...
The Fisher price and quantity indexes are superlative indexes and take approximate account of the effect of consumer substitution among the individual strata categories of goods in response to changes in relative prices. For this as well as other reasons, the measured inflation rate is a little lower and the output increase a little higher than would be the case with Laspeyres weighting.24 Even though the overall CPI is not itself used as an output deflator for consumption expenditures, its individual components are the critical elements (along with the estimates of current dollar expenditures)
|
From page 216... ...
For purposes of well-informed macroeconomic policy making, measures of national inflation, and corresponding measures of national output, ought to incorporate the prices and output of new goods as soon as practicable and also reflect changes in the quality of goods and services to the extent that they can be reliably measured, subject to the conceptual limitations discussed in Chapters 2 and 5. Pursuit of this objective must fully recognize the difficult problems that surround the use of statistical estimation techniques to produce measures of quality change and observe the cautions we express in Chapter 4 about introducing quality adjustments into the index before sufficient preparatory research is done.
|
From page 217... ...
The Technical Note at the end of this chapter compares the GDP price index, the CPI, and the NIPA price index for consumer expenditures as measures of inflation. Over the last 10 to 15 years, central banks of the economically advanced countries have increasingly come to define their principal, if not always sole, objective as the pursuit of low and stable inflation rates.
|
From page 218... ...
The central bank would have to take those changes into account in formulating its operating policy; but it would seem logical to adjust the target itself to reflect the statistical change. Since the CPI is used for indexing public transfer payments, the income tax code, and private contracts, even those methodological changes that produce relatively small differences in the annual rate of inflation can have significant consequences for government budgets and the welfare of individuals as their effects cumulate over time.
|
From page 219... ...
Aggregate NIPA inflation indexes are available quarterly for total GDP and for gross domestic purchases (including imports, by all domestic users) and for a fairly detailed set of components, including, of course, many categories of consumer goods.26 The fact that an index that includes capital goods is a useful inflation indicator does not imply that indexes of consumer prices, CPI or NIPA, should abandon the current practice of pricing the service flows from the housing stock and return (in the case of the CPI)
|
From page 220... ...
There are a number of conceptual differences TABLE 7-2 Comparison of NIPA and CPI Indexes, 1991-2000 (percent change) Year NIPA, GDP NIPA, PCE CPI-U-RS 1991 3.6 3.8 3.7 1992 2.4 3.1 2.7 1993 2.4 2.4 2.6 1994 2.1 2.0 2.2 1995 2.2 2.3 2.5 1996 1.9 2.1 2.7 1997 1.9 1.9 2.2 1998 1.2 1.1 1.4 1999 1.4 1.6 2.0 2000 2.3 2.7 3.4 NOTES: NIPA, National Income Product Accounts; GDP, gross domestic product; PCE, personal consumption expenditures; CPI-U-RS, research series using the urban consumer price index.
|
From page 221... ...
Overall, however, the two indexes move very closely together, exhibiting much the same downward trend in inflation over the period and, with the exception of 1996, roughly the same pattern of small fluctuations around the trend. Except for a 1-year deviation in 1992, the price index for GDP moves closely with the consumption price indexes not too surprisingly since consumption is two-thirds of GDP.
|
Key Terms
This material may be derived from roughly machine-read images, and so is provided only to facilitate research.
More
information on Chapter Skim is available.