Measuring The New CPI

By Daniel Kadlec With Reporting By Bruce Van Voorst In Washington

Inflation has been all but wiped off the worry screen of most Americans. But not of politicians and government statistics moles, who last week adjusted the Consumer Price Index downward for the fourth consecutive year. Stifle that yawn. The CPI, the nation's principal gauge of inflation, is not just a measure of the price of a quart of milk or a gallon of gas. It is easily the most important weapon in the government's considerable measurements arsenal. It forms the basis for annual benefits adjustments to some 80 million voters, from union workers and Social Security recipients to government retirees. Funding for food stamps and school lunches is pegged to the CPI, as are income tax exemptions and deductions and the break points between tax brackets.

"Virtually everything we do in the economy depends on the CPI," says Michael Boskin, Stanford University economics professor and former chairman of the Council of Economic Advisers. In 1996 Boskin headed a Senate commission that concluded that the CPI overstates annual inflation by about a percentage point. That means the low CPI of 1.7% last year might really have been less than 1%--a huge difference. Boskin's startling assertion accelerated the drive to find a new CPI formula while politicians began drooling over the prospect of reallocating billions of dollars freed by reduced CPI-pegged spending.

The CPI formula has been tinkered with in 1995, '96 and '97, refiguring food, housing and medical costs. Those changes shaved .3 of a percentage point off the annual rate. Last year the Bureau of Labor Statistics began tracking an experimental CPI, for the first time trying to account for rational behavior: substituting chicken for beef, for instance, when beef prices rise. That formula will be incorporated in the official CPI by next year and will trim an additional .2 of a percentage point off the annual rate.

The change last week, though, was a real haircut. For the first time in 11 years, the BLS compiled a new "market basket" of goods to track, adding things like cellular phones and auto leases and making personal computers more prominent. The BLS, which monitors some 80,000 items, added one major category, education and communication, catapulting the CPI into the information age. All the latest revisions will shave about .1 of a percentage point off the annual rate, bringing the four-year cumulative effect on the CPI to .6 of a percentage point. The White House predicts that turning a few more knobs will bring that figure to .7. Put that into real dollars, and the government saves $4 billion a year.

Officials say accuracy, not parsimony, is the goal. "Consumption patterns change," notes BLS commissioner Katharine Abraham. "New products enter the market. Old ones are modified or disappear. The market basket of today is totally different from that of a generation ago." There is a gold lining of sorts. The overstated inflation rate has kept interest rates unduly high because lenders account for inflation in setting rates. Allen Sinai of Primark Decision Economics believes that even with the changes, the CPI may be a full point too high. "Effectively, there is no inflation," he says. Now the government is making it official.

--With reporting by Bruce van Voorst in Washington

Daniel Kadlec is TIME's Wall Street columnist. Reach him at [email protected]