Thursday, July 4, 2013

Let's get over Chained CPI

By Aaron Sherman

In the United States, we tie a number of entitlements programs like Social Security to inflation. This means that as goods become more expensive, those benefits go up. This makes good sense if you want those entitlements to adapt to the economic conditions (whether or not wanting that is a good thing is beyond the scope of this article). So, you may have heard of this thing called "Chained CPI" which some politicians argue amounts to a plan to cut Social Security benefits.

That's nonsense, and just so that you know where I'm going with this, anyone who says that is lying to you. Want to find out more, or are you already plotting my death because I'm clearly one of those people? (hint: I'm not)


Still here? Fine, let's look at the details. It turns out that measuring inflation is hard, but it's essential that we do so for oh so many reasons. One way to do it is to pick a bunch of essential goods and measure their price every year. Let's make it simple and say that you pick just two goods. Regular gasoline and brown eggs. Great, so you go around measuring the price of those in every city in America for two years. On year two, you find that gas increased by 2% while eggs increased by 1%. You can average those and say that the rate of inflation was 1.5%. Done and done, problem solved.

Ah, but there's a problem! What if the price eggs going up was more than many consumers would tolerate, so they switched to white eggs? This is a fairly well known and studied problem, and not too long ago, we accounted for that by tracking the price of what people switch to. Great, solved, next.

Not yet. The problem now is that the price of eggs went up so much that many people switched to cereal for breakfast which has not been increasing in cost. Now the idea that there was real inflation is brought into question because it's not a measure of how much buying power changed by. This too has been solved by Chained CPI which tracks changes on a monthly basis and tracks moves to new replacement products which aren't just different versions of the same thing.

That's all CPI is, and every bipartisan group to look at the budget has suggested that we move to using it to track entitlements. So why don't we? Because things like Social Security payments have been growing by a bit more than inflation for a long time and no one who's getting free money wants to give it up...

How do we solve this? My suggestion is this: move to Chained CPI. Every 2 years, have a bipartisan group study the way CPI and Chained CPI have mapped to buying power and reverse the change if there's a problem (hint: there won't be).

So, why did I say that politicians are lying about this? Because they keep referring to this as a benefit "cut" but no one is arguing for lowering benefits, only scaling the increases more accurately over time.