Adjusting inflation index complex, controversial

Federal Reserve Chairman Alan Greenspan thinks the Consumer Price Index, the nation's bellwether inflation yardstick overstates inflation by failing to account for improvements in quality of goods and services, he told a Senate committee, giving people who get inflation-adjusted government benefits a windfall.

Mr. Greenspan said the CPI overstates inflation by 1 percent a year. He claimed the government could save $150 billion over five years by measuring inflation better.


The Fed chairman called for a commission to overhaul how the CPI is calculated. Would an overhaul make our chief inflation gauge more accurate, or just let politicians cut middle-class entitlements like Social Security without voting to do so?

Peter E. Kretzmer


Vice president and economist NationsBanc Capital Markets Inc.

The difficulties in overhauling it are pretty great. A lot of the problems that Greenspan was talking about refer to adjusting for quality of goods, and in the case of computer services and the like, it's very difficult to do that.

Greenspan has the courage of being the head of an independent agency, and he can say that one way to balance the budget is through entitlement spending, and you can do that through adjustments in the CPI.

For a variety of reasons, beneficiaries of government programs got bigger raises than the public at large. And real wages have grown very slowly in the private sector in recent years.

So it seems particularly opportune to shave a little off and reduce the growth rate of these government benefits.

Of course, it's a political hot potato, and you might just make the decision that [reducing spending] should be unrelated to the quality of CPI.

Elliott Platt

Director of economic research Donaldson Lufkin & Jenrette Securities Corp.


As long as the degree to which it's overstated has some constancy, then it's useful because the accelerations and decelerations can be tracked.

One of the complaints is that the market basket [of prices] is fixed, but that people make substitutions -- for instance, when the price of one thing goes up, people switch to a lower-priced substitute.

To a large extent, Greenspan has to also be interested in relative change. Let's say we took the recent CPI data, where the year-over-year change was 3.2 percent: if Greenspan and company really believe it's overstated by 1.5 percent, one might question why they've been tightening [raising interest rates].

If however, they're interested in relative changes, then it behooves them to always be vigilant in any upward shift in the rate of inflation.

Paul W. Boltz

Chief economist and managing director T. Rowe Price Associates Inc.


Mr. Greenspan is sure the CPI exaggerates inflation, but a lot of people are not so sure of that. There is considerable disagreement over how much it may be overstating the true cost-of-living escalation. I think a commission or group of scholars to look into this is a good idea. This is a very far-reaching number. There are two things households watch closely: the CPI and the unemployment rate. Those are the two components of the misery index: inflation plus unemployment equals misery. Those should be the best numbers the government produces.

The problem is discounting cost gains for productivity. Figuring out how much [of price gains] is due to quality changes and how much is inflation is a very difficult issue. You get into some almost philosophical questions. Let's say a new drug comes out. It costs much more than the old medication, but it works much better. How much of that is inflation?

These are not obvious issues. If they were, the BLS would have fixed them years ago.

Cynthia M. Latta

Senior financial economist DRI/McGraw-Hill Inc.

It's a way to do through the back door what Congress won't do by the front door. From the point of view of the Fed, it makes their inflation-fighting job easier. You can argue that inflation hasn't happened at all. But you can argue that it's not an increase in the standard of living if you have no choice.


From the Fed's point of view, if you pay more for a car because it has air bags in it, that's not the kind of inflation the Fed is trying to fight. To the Fed, that's not inflation that's legitimate. But if you come up with a CPI that makes Greenspan happy, it won't make pensioners happy. They'll say, 'I have to buy the air bags. My cost of living has gone up.'

I think both positions are quite legitimate. My thought that the commission was a wacko idea was that every time you have one of these commissions, it meets for a long time and comes up with nothing. It may just make the CPI more political.