Wednesday, March 18, 2015

The Experimental Consumer Price Index

The Bureau of Labor Statistics releases its monthly Consumer Price Index (CPI) data each month, a measure that most of us think of as the rate of inflation.  The CPI measures the average change in prices over time for a fixed market basket of goods and services.  The CPI can be divided into two parts; the CPI for All Urban Consumers or CPI-U which represents the spending habits of about 80 percent of Americans and its subset, the CPI for Urban Wage Earners and Clerical Workers or CPI-W which represents the spending habits of about 32 percent of all Americans.

Under the Older Americans Act of 1987, the BLS also calculated a little-known experimental price index called the Consumer Price Index for the Elderly or CPI-E which measures the spending habits of Americans aged 62 and older.  The population used in this measure had to meet one of these three conditions:

1.) They had to be unattached individuals who were at least 62 years of age.

2.) They had to be a member of a family whose reference person or spouse was at least 62 years of age.

3.) They had to be a member of a group of unrelated individuals who live together and pool their resources to meet their living person whose reference person was at least 62 years of age.

Obviously, older Americans spend money differently than their younger counterparts, particularly when it comes to expenditures on medical care and shelter as shown in this table which compared the percent of average annual expenditures on various components by age as compared to what is spent by average Americans as a whole:

Originally, the study of the experimental CPI-E covered the time period from December 1982 to December 1987 and was then expanded to cover the period up to December 1993.  The result of the expanded study were covered in a paper by Nathan Amble and Kenneth Stewart.  At that time, they found that, over the period from December 1987 to December 1993, the experimental price index or CPI-E rose by 28.7 percent, higher than the 26.3 percent increase for the CPI-U and 25.5 percent increase for the CPI-W.  When the data was examined more closely, the authors found that the biggest price increases for the elderly were found in medical care; during the six year period, the cost of medical care rose more than twice as fast as the average for all items in each population group, rising at 59.4 percent between 1988 and 1993 for the elderly, compared to 54.2 percent for the broadest measure of consumers (CPI-U).  

Here is a table showing how each of the three CPI measures looked during the period from 1988 to 1993:

While a few percent here or there may not seem significant, in fact, over decades it adds up as shown on this graph from FRED which shows the most commonly reported CPI-U measure in red and the CPI-E measure for older Americans in blue:

Over a period of decades, it is quite obvious that the cost of living for older Americans has risen substantially above their younger counterparts.

What are the real world consequences of this difference?  Right now, Social Security benefits increase once annually to ensure that older Americans do not experience a decline in their standard of living as a result of rising prices.  These increases are tied to the CPI-W which reflects the spending habits of all American urban wage earners and clerical workers.  Obviously, the purchasing patterns of retirees differ significantly from their younger counterparts and, as noted above, inflation for older Americans is higher than for their younger counterparts.  While several attempts have been made to change this policy, none have succeeded.

While it is somewhat dated, a 2003 study by Burt Hobijn and David Lagakos looks at what would happen to the social security trust fund, officially known as the Old-Age and Survivors Insurance (OASI) trust fund.  Obviously, since inflation is higher for older Americans, using the CPI-E rather than the CPI-W would mean that payouts from the OASI trust fund would be higher.  The authors used two different scenarios; the first assumed that CPI-E was 0.22 percent higher and the second assumed that CPI-E was 0.38 percent higher than CPI-W.  Here is a chart showing three scenarios; the trust fund's declining balance under the current CPI-W projections and the trust fund's declining balance under the two CPI-E projections with the year along the horizontal axis and the funding ratio along the vertical axis:

If the CPI-E was adopted and inflation rate for seniors was 0.22 percent higher in each year, the fund would become insolvent in 2041, two years before the projected insolvency date of 2043.  If the inflation rate for seniors was 0.38 percent higher in each year, the fund would become insolvent in 2038, five years earlier than under the current scenario.

Given that senior Americans have experiencing consistently higher levels of inflation over the past three decades, policymakers have a difficult decision to make, particularly in light of the aging population.  They can either maintain the purchasing power of senior citizens or they can prolong the solvency of the social security trust fund.

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