"The Consumer Price Index overstates increases in the
cost of living by about 1.1 percentage point a year."
Michael Boskin, Stanford University 1
According to recent surveys, most professional
economists believe that the Consumer Price Index (CPI) consistently
overstates the cost of living in the United States by one percentage
point or more. Even promarket economists such as Michael Boskin and
Milton Friedman assert that the CPI, which is prepared monthly by the
Bureau of Labor Statistics, exaggerates changes in the living expenses.
As a result of these studies, the government hopes to
establish a more accurate CPI and thus save Washington billions of
dollars. The CPI is used to index federal taxes and Social Security
payments. A lower CPI could increase tax revenues by $70 billion and
reduce Social Security checks by $75 billion over a five-year period. It
could substantially reduce the federal deficit.
The CPI is determined each month by a survey of prices
of 364 items that compose a typical bundle purchased by urban consumers
during the base period, 1982-84. Items include food, consumer goods and
services, rent, and property taxes. Each month several hundred survey
workers visit approximately 21,000 stores in urban areas and collect
prices on these items. The CPI is a market basket index of these items,
valued according to a weighted average.
What's Missing in the CPI?
Unfortunately, the price-index methodology is defective
in two ways. First, the current CPI fails to take into account quality
improvements, new products, substitutes, and sale prices. As a result of
these omissions, many economists argue that the CPI tends to
overestimate the cost of living in the United States.
Second, the CPI does not include all items determining
an individual's cost of living, and this fact may cause the CPI to
consistently underestimate the cost of living. How many people buy a
fixed market basket of goods and services that match in any way the
government's survey for "an urban family of four"?
For example, I have two children in college. According
to government surveys, college tuition and related expenses have risen
at double-digit rates over the past decade or two. But the CPI doesn't
cover college expenses.
My family and I also travel frequently outside the
United States. Overseas the dollar has lost much of its purchasing power
over the past 20 years. How does the CPI reflect the dollar's decline?
It doesn't.
Crime has been a problem in our community, so we bought
an expensive security protection plan for our home. The CPI doesn't
include such an expenditure in its fixed basket of services.
What if interest rates rise? The CPI does not directly
account for the costs of borrowed money or mortgage payments.
The Biggest Omission
But probably the most serious defect of the CPI is that
it does not register the largest item in everyone's household
budget-taxes. The CPI covers property taxes, but not sales taxes or
income taxes. Today, government expenditures (the most accurate measure
of total taxation) represent 32.2 percent of the economy (GDP). If the
CPI is supposed to represent the cost of living, doesn't it make sense
that it should include taxation, the cost of government?
Taxes and government spending have been rising rapidly
throughout the twentieth century, as the following graph shows:
Since 1982-84, the base period for the current CPI,
total government expenditures have increased from $1.1 trillion to $2.5
trillion, a 127 percent increase. During this same period, the CPI has
risen only 60 percent. Clearly, if taxes were included in the CPI, it
would be rising at a much higher rate.
In short, you have two major deficiencies in the CPI,
one that overestimates inflation and another that underestimates
inflation. Which force is stronger? I don't know, but it would be
national folly to include the former and ignore the latter.
Mises to the Rescue
In determining the best measure of inflation, we should
remember the words of Ludwig von Mises. Mises refers to the "level" of
prices as "inappropriate" and "untenable" because "changes in the
purchasing power of money must necessarily affect the prices of
different commodities and services at different times and to different
extents." He goes on to say, "The pretentious solemnity which
statisticians and statistical bureaus display in computing indexes of
purchasing power and cost of living is out of place. These index numbers
are at best crude and inaccurate illustrations of changes which have
occurred. 2
According to Mises, inflation (deflation) is defined as
increases (decreases) in the supply of fiat paper money by government,
not changes in the prices of individual goods and services. According to
this definition, the cost of living and declining purchasing power of
the dollar have been extraordinarily and un-necessarily high in modern
times. If we use the monetary base (funds on deposit by the Federal
Reserve) as a measure of fiat money, the money supply has increased 141
percent since the 1982-84 base period. If we use a broader definition,
M2 (coins, currency, checking accounts, and money market funds), the
money supply has increased 75 percent. Either way, monetary inflation
has been significantly higher than the CPI's 60 percent. Perhaps
increases in the money supply should be used as a better gauge of
inflation. But it wouldn't make Washington happy - it would mean less
tax revenue and higher Social Security checks.
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Department of Economics and
editor of Forecasts & Strategies, one of the largest investment
newsletters in the country. The third edition of his book Economics
of a Pure Gold Standard has recently been published by FEE.
1. Wall Street Journal, February 25, 1997, p. A24.
Professor Boskin headed a government panel investigating the CPI.
2. Ludwig von Mises, Human Action, 3rd ed. (Regnery,
1966), p. 222.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
May 1997, Vol. 47, No. 5.
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