South-Western College Publishing - Economics  

Will the New CPI Measure Up?
Subject Inflation
Topic(s) Measure of Inflation; Consumer Price Index; Cost-of-Living
Key Words CPI, Measure of Inflation, Cost-of-Living Adjustments, Federal Income Tax, Substitution Bias
News Story

The Consumer Price Index (CPI) is most often used to measure inflation. The CPI is used to determine the cost-of-living adjustments for federal pensions and Social Security recipients, to adjust the standard deduction and tax brackets for the federal income tax, and is incorporated into a number of private contracts and leases as an inflation adjustment. Given the importance and extensive usage of the CPI, it is not surprising that its accuracy has been studied and questioned. Partly in response to a variety of criticisms, the CPI has undergone a number of revisions.

The Bureau of Labor Statistics (BLS), the government organization that supervises the calculation of the CPI, announced the last of a series changes begun in 1995 to correct the CPI for biases. It is estimated that the cumulative effect of all the changes is to trim the measure of inflation by eight-tenths of a percent. The last change, amounting to two-tenths of a percent, is designed to account for substitution bias--the tendency for consumers to buy more of a similar product that is relatively less expensive.

Lowering the rate of increase in the measure of inflation will have a significant impact on the federal budget and the economy. Tax revenues will increase since the income tax bracket, standard deduction and personal exemption will be smaller than they otherwise would have been. Government expenditures for cost-of-living adjustments, like Social Security benefits, will increase less rapidly under the new measure. With higher tax revenues and lowered expenditures, the impact on the federal budget is to reduce the deficit or increase the surplus. The impact on retirees affected by the change will be to lower their benefits. (Updated May 19, 1998)

  1. How is the CPI calculated?
  2. Do students as a group experience the same amount of inflation as an average urban family of four? Why or why not?
  3. What are some of the biases in the calculation of the CPI?
Source John M. Berry, "U.S. to Change the Way it Measures Inflation", Washington Post, April 17, 1998.

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