How Chained Consumer Price Index Proposed by Obama
Works to Curb Social Security Benefits
Bureau of Labor Statistics provides a Q&A about
inflation calculation that will slow cost-of-living adjustments for
April 11, 2013 – The term “COLA” is a part of the
Social Security program that has been highly cherished by senior
citizens. It stands for “cost-of-living adjustment,” and was the
government’s way of being trying to keep retired older Americans from
seeing their Social Security benefits eaten away by inflation. Now, the
Obama administration has come up with a new way to calculate inflation
that will reduce COLA in the future. It is called the chained consumer
price index and below is a Q&A on this method provided by the Bureau of
Frequently Asked Questions about the Chained Consumer
Price Index for All Urban Consumers (C-CPI-U)
What is the C-CPI-U and when did the Bureau of Labor Statistics (BLS)
begin publishing it?
BLS began publishing the Chained Consumer
Price Index for All Urban Consumers effective with the release of July
2002 CPI data. Designated the C-CPI-U, the index supplements the
existing indexes already produced by the BLS: the CPI for All Urban
Consumers (CPI-U) and the CPI for Urban Wage Earners and Clerical
C-CPI-U employs a formula that reflects the effect of substitution that
consumers make across item categories in response to changes in relative
2. What is
substitution and substitution bias? And does the C-CPI-U eliminate it?
Traditionally, the CPI was considered an upper bound on a cost-of-living
index in that the CPI did not reflect the changes in consumption
patterns that consumers make in response to changes in relative prices.
Most media reports say focus of White House is to
strike a ‘Grand Bargain’ with Republicans who want to change Medicare
into a voucher-style system; Medicare proposal has one revenue
item - higher premiums for couples making more than $170,000 a year
Since January 1999, a geometric mean formula has been used to calculate
most basic indexes within the CPI; this formula allows for a modest
amount of substitution within item categories as relative price changes.
geometric mean formula, though, does not account for consumer
substitution taking place between CPI item categories. For example, pork
and beef are two separate CPI item categories. If the price of pork
increases while the price of beef does not, consumers might shift away
from pork to beef. The C-CPI-U is designed to account for this type of
consumer substitution between CPI item categories. In this example, the
C-CPI-U would rise, but not by as much as an index that was based on
fixed purchase patterns.
the geometric mean formula in place to account for consumer substitution
within item categories, and the C-CPI-U designed to account for consumer
substitution between item categories, any remaining substitution bias
would be quite small.
Key Links on
President Obama’s Proposed 2014 Budget
When did you decide to use a cost-of-living (COL) index as a framework
for the CPI, and why is the CPI still not a COL?
C-CPI-U does not represent a fundamental change in the underlying
objective of the CPI. BLS has long used the concept of a cost-of-living
(COL) index as a framework for dealing with practical questions that
arise in the construction of the CPI.
While the C-CPI-U accounts for consumer substitution, the CPI still
differs from a complete, or "unconditional," cost-of-living measure.
While the CPI measures changes over time in the cost of consumer goods
and services, an unconditional cost-of-living index would go further,
and take into account changes in non-market factors, such as the
environment, crime, and education. The CPI is said to be "conditional"
on those factors.
How is the C-CPI-U constructed and how is it different from the CPI-U
the CPI-U and C-CPI-U are indexes designed to measure price changes
faced by urban consumers, while the CPI-W is designed to measure price
changes faced by urban wage earners and clerical workers. Population
coverage is the only difference between the CPI-U and CPI-W. The C-CPI-U
is further distinguished from the CPI-U and CPI-W based upon the
expenditure weights and formula used to produce aggregate measures of
background, all three of the CPI indexes are built in two stages. In the
first stage, prices for each of the 8,018 item-area combinations (211
item categories X 38 geographic areas) are averaged together to form
8,018 basic indexes. This stage is often referred to as "lower-level
aggregation" as it involves averaging the prices within item-area
groups. For example, price changes for apples within Chicago are
averaged together to produce the Chicago-apples index.
1999, the BLS introduced a geometric mean formula for averaging prices
within most of these item-area combinations, in order to approximate the
effect of consumer response to changes in relative prices within these
item categories. The geometric mean estimator is used in the C-CPI-U in
the same item categories in which it is used in the CPI-U and CPI-W.
the second stage, sometimes referred to as "higher-level aggregation",
these 8,018 elementary indexes are averaged together to yield various
aggregate indexes and ultimately the All-Items, U.S. City Average index
of price change. It is at this second stage where the C-CPI-U is
different from the CPI-U and CPI-W. The use of a superlative formula for
upper-level aggregation, used in the final C-CPI-U, is designed to
address consumer substitution across item categories. In contrast, the
CPI-U and CPI-W use a formula that assumes consumers do not substitute
across item categories.
the CPI-U and CPI-W, expenditures from a previous (or lagged) two-year
period are used to calculate aggregate indexes. These weights remain
fixed for 24 months before being replaced with updated expenditures. For
example, the CPI-U for the years 2004 and 2005 uses expenditure weights
drawn from the 2001-2002 Consumer Expenditure Surveys.
final C-CPI-U, on the other hand, utilizes contemporaneous monthly
expenditure estimates for each of the 8,018 elementary indexes. For
example, the final C-CPI-U for May 2003 is based on monthly expenditures
for April and May 2003. As such, expenditure data required for the
calculation of the C-CPI-U are available only with a time lag. Thus, the
C-CPI-U is issued first in preliminary form, and is subject to two
example, "final" values of the C CPI-U have been issued for data through
2003. "Interim" values are available for the 12 months of 2004, and
"initial" values are available for 2005 data. In February 2006, with
release of the January 2006 index, revised interim indexes for the 12
months of 2005 will be published, and the index values for 2004 will be
revised and become final. In each subsequent year, indexes for the
months in the year two years prior will be issued in final form and
those values for one year prior will be revised and issued as interim.
its final form, the C-CPI-U is a monthly chained price index with the
expenditure weights varying each month. The CPI-U and CPI-W, on the
other hand, are biennial chained price indexes where their expenditure
weights are updated every two years. Within the two-year span, these
indexes are fixed-weight series, where the changes in these indexes
reflect only changes in prices, and not expenditure shares, which are
detailed information on how the C-CPI-U is constructed can be found in
"Introducing the Chained Consumer Price Index" (PDF).
5.Where is the
C-CPI-U currently being used? Wouldn't the C-CPI-U be a more appropriate
index to tie Social Security or other adjustments to?
C-CPI-U, which in final form is said to be a "superlative" index, is
designed to be a closer approximation to a cost-of-living index than
other CPI measures.
said, BLS publishes thousands of indexes each month; these indexes can
vary by which items, geographic areas, and populations are covered. As
different users have different needs, BLS cannot say which index is
necessarily better than another. As such, BLS takes no position on what
the Congress or the Administration should use to make adjustments to
Social Security or any other federal program.
C-CPI-U to our knowledge currently is not used in any federal
legislation as an adjustment mechanism.
it possible for the C-CPI-U to increase faster than the CPI-U?
lower levels, and for short periods of time, it is possible for the
C-CPI-U to increase faster than the CPI-U. That said, the evidence
suggests that the C-CPI-U over time will trend slightly lower than the
the difference between the CPI-U and the C-CPI-U expected to be fairly
stable over time?
Earlier evidence suggested that the difference between the CPI-U and the
C-CPI-U would be around 0.2 percent a year. For the period December 1999
to December 2000, however, the difference was 0.8 percentage point.
There were a number of reasons for the larger difference, including the
relative age of the weights in the CPI-U, and the increased variation in
price movements across CPI item categories, causing the divergence
between the CPI-U and C-CPI-U to grow. In each of the last four years
(including 2004, for which the C-CPI-U values are not final), the
difference in December-to-December changes was 0.3 or 0.4 percentage
The C-CPI-U is subject to revision. How small are these revisions
expected to be?
C-CPI-U is issued first in preliminary form, and subject to two
subsequent revisions. These revisions have been relatively small, and
are expected to be small in the future. Revisions to 12-month changes in
the All Items index, for example, generally have been 0.2 index points
9.For a given month,
will the initial release of the C-CPI-U always be lower than the interim
or final release?
The initial release uses an "adjustment factor" to estimate the initial
indexes. This adjustment is designed to prevent the initial indexes from
being systematically higher or lower than the interim and final indexes.
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