How To Rewrite Economic History

The Boskin Commission's attack on the Consumer Price Index is weak on the merits and scary as policy.
 


The Consumer Price

"THE one duty we owe to history is to rewrite it," Oscar Wilde said. In line with that aphorism, the Advisory Commission to Study the Consumer Price Index, chaired , has rewritten the economic history of the past twenty-five years. The Boskin Commission was formed at the behest of the Senate Finance Committee. Last December it released its long-awaited report on the CPI. The commission reported its conclusion that the CPI overstates the rate of cost-of-living inflation by 0.8 to 1.6 percentage points a year; its best estimate was that inflation is overstated by 1.1 percentage points. If cost-of-living inflation has been overstated, then the growth of the economy and real wages has been much higher than previously reported. The commission has thus solved the problem of stagnating wages, which is now revealed to be a mere fiction. Far from experiencing a "silent depression," the commission implicitly claims, American families have never had it so good.


The political implications of this rewriting of history are obviously enormous. The commission's findings are being used as a cloak for an economic agenda that will injure lower- and middle-income households. By "cooking the books" the commission threatens to undermine the dawning consciousness that the U.S. economy is no longer delivering prosperity for huge segments of society. Clearly, its findings need to be substantively examined before being accepted.

Unfortunately, the majority of the American economics profession appears to have uncritically accepted the commission's finding that inflation is overstated; this implicitly makes a mockery of the profession's own intellectual accomplishments. If inflation, wages, and income have all been misstated, years of research have been conducted using incorrect data. Thus much of this research, which purportedly confirmed the profession's theoretical claims, is no longer valid.
 

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The Boskin Commission cited four reasons for the CPI's mismeasurement of inflation: product-substitution bias, outlet-substitution bias, quality-change bias, and new-product bias. The CPI measures the cost of a given basket of goods in which the quantity of each good is based on the amount that the average consumer was buying on the date the index was calibrated. Product-substitution bias emerges because over time consumers alter the goods they buy, and consequently the bundle of goods that the CPI is tracking no longer represents consumer spending patterns. The Boskin Commission claims that consumers have been substituting low-inflation goods and that the CPI has been oversampling high-inflation goods.

Outlet-substitution bias arises because consumers have been changing the places where they shop, shifting from high-priced department stores to lower-priced discount stores. But the CPI oversamples department-store purchases and undersamples discount store purchases.

Quality-change bias reflects the fact that products tend to improve in quality over time, and thus consumers are effectively getting more product for their money. The CPI not only may fail to capture this improvement in quality but also may register quality improvements as price increases, since improving quality sometimes adds to cost.

New-product bias arises because new products are only gradually incorporated into the CPI basket of goods. But the prices of new products tend to fall rapidly soon after the products are introduced, and thus the price decline is not captured by the CPI.

The cornerstone of the Boskin Commission's findings is sample-selection bias in the construction of the CPI -- that is, the CPI basket of goods oversamples high-inflation goods and undersamples low-inflation goods and goods whose prices are falling. The commission is itself a delicious example of such bias: All its members were on record prior to the establishment of the commission as believing the CPI to be overstated. At the same time, the commission took no evidence from such well-known economists as Janet Norwood, a former head of the Bureau of Labor Statistics, and Dean Baker, of the Economic Policy Institute, who believe that the CPI provides a reasonable reading of inflation. In effect, the commission took account of all the evidence of overstatement of inflation by the CPI and downplayed the evidence of potential understatement.

The Bureau of Labor Statistics, which is responsible for maintaining the CPI, has long been aware of the different biases identified by the commission, and it carefully and scrupulously adjusts the CPI to root them out. Whereas the Boskin Commission conducted no new research, the bureau conducts frontier research on the CPI. The government's statistical agencies have a history of producing very fine statistical work. Attacking their statistics damages their credibility and clouds the nation's political and economic understanding.

Contesting the technical details of the commission's arguments, Dean Baker has pointed out that the CPI could possibly understate inflation. For example, the CPI fails to take account of the greater contributions for health-insurance premiums and doctor co-payments that have increasingly been forced on American households. It fails to take account of increased traffic congestion, which raises the cost of commuting.

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