Monday, February 25, 2013 —
The CPI tracks prices in a “market basket” of products and services typically bought by households. The prices are weighted by their relative importance to households’ overall spending – meaning, for example, gasoline gets a larger weight than a can of peas – and then the weighted prices are averaged and converted to an index for ease of comparison. So, for example, a CPI of 200 compared to a CPI of 100 indicates weighted average prices have doubled. CPI values can be found at www.bls.gov.
So the CPI sounds reasonable, right? Not everyone agrees. One criticism has been that changes in the CPI won’t reflect how prices change for every household, because people differ in what they buy in their market basket.
Of course, this is correct, but we shouldn’t expect the government to have a customized CPI for every household. However, while conceding this point, retired households have long complained that their spending patterns do markedly differ due to the larger proportion spent on medical care. This has led to calls for a special “senior citizen CPI” to adjust Social Security pensions.
But the new COLA conflict is over a different issue. It has to do with how frequently the market basket is updated. The current CPI assumes that what we buy changes infrequently, approximately every two years.
Of course, this is unrealistic. Therefore, a revised CPI – the “chained CPI” – has been developed. It is designed to reflect changes in household buying over time due to two factors: as new products are introduced or buying preferences change and as we shift out of products and services where prices have risen to products and services where prices have fallen or remained stable.
It’s the last factor that has created the controversy. Say the price of gasoline jumps. The traditional CPI would assume we would continue buying the same gallons of gasoline, so the full impact of the gas price increase would be reflected in the CPI.
Yet under the new chained CPI, there would be an assumption we would purchase slightly fewer gallons, so the “weight” in the gasoline component of the CPI wouldn’t be as large as with the traditional method.
This means inflation with the chained CPI will be more modest, and programs like Social Security will save money because pensions to retirees will rise at a slower pace. Indeed, calculations suggest Social Security could save more than $100 billion over the next decade if the chained CPI is used to adjust future payments.
This has led some to claim that using the chained CPI for the Social Security COLA would mean a cut in payments for retirees. Other say no, it’s merely a more realistic COLA that will extend the life of Social Security.
Since I’m now eligible to receive Social Security, I’ll be watching this COLA war if it is renewed. So, what’s the right COLA for you? You decide.