[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Internet Connection
IMPROVING OUR MEASURE OF THE CPI
The Bureau of Labor Statistics undertook a major revision of
the consumer price index in 1998. Details of the changes can
be found at www.bls.gov/opub/mlr/1996/12/art1abs.htm.
On average, prices rose 305 percent from 1973 to 2002. Figure 23.2 shows the CPI since
1913.
Case in Point
THE PRICE INDEX MAKES A DIFFERENCE
Price indexes increasingly have come to play an important role in recent economic
debates. The Social Security benefits of the elderly rise with the cost of living index
(the CPI), 2 and tax brackets and tax exemptions also change with the index. If the
index overstates the increases in the cost of living, the real benefits (purchasing
power) of the elderly increase, and real inflation-adjusted tax revenues fall. Both
distortions increase the budget deficits of the government—the first by increasing
its outlays, the second by reducing its receipts.
By early 1994, it had become apparent that the price index the federal government
used for adjusting both benefits and tax brackets was seriously flawed—overstating
the rate of inflation by between 0.5 and 1.5 percent a year. The government made
several changes to partly correct the errors in the index.
The upward bias stems from three problems. The first is the “fixed basket problem.”
The CPI is calculated by comparing how much it costs to purchase a particular
market basket of goods that represents an average consumer’s expenditure
pattern. But expenditure patterns change steadily over time, while the market basket
is revised only infrequently. For instance, in February 1998, the market basket was
revised; it is now based on spending patterns in 1993–1995; previously it was based
on 1982–1984 expenditure patterns. As people buy more of the goods that have
become relatively less expensive (such as computers) and less of the goods that have
become relatively more expensive, the index increasingly overweights goods whose
prices have risen the most.
2 When a worker retires, his or her initial Social Security benefits are determined by a formula that is indexed
to the general level of wages. However, once a worker begins to receive benefits, future benefit levels are indexed
to the CPI.
516 ∂ CHAPTER 23 THE COST OF LIVING AND INFLATION