From the Boring But Important Files: Chained CPI

This post marks the launch of a new category for this blog called Boring But Important (BBI). Today's BBI story is about chained CPI and why it might be responsible for decreases in social security. The details from Atlantic Wire:

The budget that President Obama introduced today calls for "$230 billion in savings from using a chained measure of inflation for cost-of-living adjustments throughout the Budget." Because the measure of inflation is so important when it comes paying Social Security benefits and setting tax rates, a minor technical change could have a huge ripple effect on the economy…

CPI is the Consumer Price Index, which is the most basic measure of inflation. It's an official, government-approved number produced by the Bureau of Labor Statistics, and all kinds of government and private programs rely on the CPI to make yearly adjustments for the cost of living.

Early in the last decade, economists began to argue that CPI is not the most accurate measure of inflation, because it merely aggregates prices and doesn't take into account how people spend their money in the real world. Specifically, it doesn't account for consumers' ability to substitute one product for another when prices change. (For example, if the price of butter goes up, people can switch to margarineand save money. Click here for more discussion of the "substitution effect.") So in 2002, the BLS createdthe Chained CPI, which many experts say is a better measure of the actual "cost of living." (For some people, anyway. We'll get back to that in a bit.) That's why it's also known as Superlative CPI.

Not only is the Chained CPI more accurate, it predicts that inflation grows at a slower rate than regular CPI. In any given year, the difference between the two numbers is minor—only about one-third of one percent—but over time, the effect on budgets can be massive. Because each year's CPI is based off the previous year's number, the effect compounds, meaning a small change now creates a huge difference in the final number 10 or 20 years down the road. Switching from regular to Chained (again, a 0.3-percent difference each year) would save more than $200 billion in inflation-mandated spending over the next decade.

Anyone who's been paying attention knows that we average Americans suck at math. Maybe that's what they're counting on.

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