The Meaning of CPI Bias

Dean Baker and Jared Bernstein:

Dean Baker argues that new good bias in the Consumer Price Index has only a small effect on our estimates of the lifestyles of the poor and working--as opposed to the lifestyles of the rich and famous, where it has a bigger impact:

Beat the Press: Middle Class Living Standards: Changing the Yardstick: The story on middle class living standards over the last quarter century is pretty bleak.... [M]any of those arguing that living standards actually have been increasing rapidly go behind the data and argue that the consumer price index (CPI) overstates the true rate of inflation.... David Leonhardt presents this case today based on the anecdotes of Robert Gordon, a member of the notorious Boskin Commission, and one of the leading proponents of this view. As the Boskin Commission's primary opponent, I can't let this one slide.

This issue raised in the column is the question of "new goods bias," the idea is that some goods enter the market initially at very high prices, but then the price drops rapidly in their first years on the market. The bias results from the fact that the consumer price index (CPI) does not include the new product until after its period of rapid price decline, therefore missing large prices declines that would lower the average rate of inflation. This would have been more of a problem in prior decades....

I always thought that the claims about the size of new goods bias were probably overstated, but insofar as it exists, it is primarily something that leads to an overstatement of the CPI for rich people. The example of the snow blower that Leonhardt highlights in his column is probably a good one to illustrate the basic issue.... The key question is how many people bought snow blowers in the fifties when they were clumsy and expensive? Probably not many, and those who did were mostly rich people who could afford expensive toys. Most of the drop in snow blowers' prices took place before the middle class began to buy them. This drop provided a gain to those who already were buying snow blowers, but it provided zero gain to those who found them too expensive to be worth their money....

During the Boskin controversy people often cited the example of the cell phone, which managed to slip through the cracks until the mid-nineties (97, if I remember right).... I once debated an economist... asked him how much this oversight led to an overstatement in the cost of living for the half of the population that still didn't own a cell phone.... [R]emembering economic theory, he gave the correct answer "zero."

Of course, the cell phone was an extreme case... but in general the story of new goods with big price declines not being picked up in the CPI was a story that affects the cost of living of the rich... not an issue that affects middle class living standards.

Jared Bernstein argues that our knowledge of the size of the bias is shaky, and that it is a distraction from more important debates:

That Distracting Living Standards Debate: Jared Bernstein

Let us now discuss David Leonhardt’s article this AM in the NYT, specifically, the adjustment to the CPI that changes flat male median real earnings into a real growth rate of around 27% http://www.nytimes.com/2006/09/20/business/20leonhardt.html?ex=1316404800&en=8edad6d6ede72817&ei=5090&partner=rssuserland&emc=rss.

The argument in the paper focused on the “new goods” bias in the CPI: the problem of not incorporating new goods into the index until they’ve fallen a lot in price (thus missing the price decline). Dean Baker raises good questions.... I just wanted to raise a few other points....

3) There is a false degree of certainty to these bias adjustments.... Jack Triplett http://www.csls.ca/ipm/12/IPM-12-Triplett-e.pdf notes: "...what I liked least about the Commission Report was exactly what made it so influential — its guestimate of 1.1 percentage points of bias."...

That does not mean living standards have deteriorated. Living standards comprise many different aspects of life, from health advances to cheaper gadgetry.... But... this middle-class debate... I fear it’s a distraction.... [R]ight now, those of us who seek a different set of policy responses to the big challenges we face... would be better off talking much more about that agenda, and not arguing over whether the middle class is better off relative to 30 years ago.

That argument also sets an incredibly low bar. Real GDP... per-capita, [up] something like 90% [over the past three decades).... [T]he more important points are a) anyway you cut it, the middle-class was reaping much more of the benefits of the growing economy years ago than they are now, and b) as the structure of the economy and job market has changed, the distributional institutions—-unions, minimum wages, fiscal policy, full employment-—far less operative today.

Finally, as Leonhardt sort of suggests, it's a political distraction to have this debate about the 30-year record. The last six years are where all the political action is: we've had stellar productivity growth, but the real median household income of working age families is down 5%, $3,000 in 2005 dollars (2000-05). This is an incredible indictment of the current economic regime (and of YOYO economics--see http://www.noyoyoeconomic.com yet the elites are scratching their heads wondering why people don't get how great they're doing.

I am in broad agreement with Robert Gordon on the potential size of CPI bias, with Jared Bernstein on our lack of knowledge of how large it really is, and with Jared Bernstein again that a big CPI bias should not make us feel happy about the income distribution. And I tend to weigh in against Dean Baker on the size of CPI bias, against Bob Gordon (or at least against Mike Boskin) on how certain we are of our estimates, and with all three (i.e., all except Mike) that America would be a better place with more social democratic policies. Moreover, the bigger CPI bias, the more social democratic we should be.

Think about it. If there is 20% of CPI bias in the past 30 years, then median male real earnings have risen by 30% instead of the 10% in official statistics. But real national income per capita has risen by 125% rather than by 90%. A country that is so phenomenally more productive than the country of the mid-1970s should be able to do a much better job at providing an economic environment in which all Americans can have greatly improved income security, education for their children, and leisure time, as well as a much greater share in the rises in real material standards of living of which the rich have grabbed the lion's--no, much more than the lion's, the tyrannosaurus's--share.

Comments

[save_the_rustbelt]

Let's see if I understand this.....

Since we now have snow blowers and cell phones we can survive something as tiny as having our pensions evaporate.

Hey, now that makes sense to me.

And why not destroy our manufacturing sector, why hell, we got snow blowers and cell phones, who needs those jobs.

[Chris]

PEDANT ALERT
No, if you remember your Aesop, you can't take more than the lion's share;

The Lion went once a-hunting along with the Fox, the Jackal,and the Wolf. They hunted and they hunted till at last they surprised a Stag, and soon took its life. Then came the question how the spoil should be divided. "Quarter me this Stag," roared
the Lion; so the other animals skinned it and cut it into four parts. Then the Lion took his stand in front of the carcass and
pronounced judgment: "The first quarter is for me in my capacity as King of Beasts; the second is mine as arbiter; another share comes to me for my part in the chase; and as for the fourth quarter, well, as for that, I should like to see which of you will dare to lay a paw upon it."

As usual, Brad is thinking like a liberal, not a lion.

[Denis Drew]

In 1965 I paid for a 15" b&w Panasonic TV over 12 months because I didn't want to put out what must have been $700-800 in today's money all at once. A few years later I bought a Consumers Reports "best buy" FM reciever for $1800 in today's money (Lafayette 1500 -- "low price", high quality).

Today every disability case living in a flea bag hotel has both color TV and a better reciever. But they are still welfare cases living in flea bags and still cannot afford to get their teeth fixed.

My point is that American labor below 50 percentile income wants an equal share of the income growth that the CPI -- DOES -- measure as well as the free gifts of technology.

[Blissex]

«As the Boskin Commission's primary opponent, I can't let this one slide.»

I suppose that Dean Baker would like to be considered that, but I would like to introduce the very interesting contribution (mentioned IIRC in Barry Ritholtz's excellent blog:

http://WWW.ShadowStats.org/
http://WWW.Weedenco.com/welling/Downloads/2006/0804welling022106.pdf
«If the numbers don't seem real to the man in the street, they probably aren't.
Real unemployment right now -- figured the way that the average person thinks of unemployment, meaning figured the way it was estimated back during the Great Depression -- is running about 12%.
Real CPI right now is running at about 8%.
And the real GDP probably is in contraction. I venture that if you talked about those numbers now with the average person, they would say that they seem reasonable. If you tell them that people are playing with the official numbers, they say, "Yep, I figured that. There are no great surprises there." I guess what I am saying is that my work shows that the economic perceptions of non-professionals actually have some real validity; there are in fact reasons for the disconnect between official statistics and what the populous is feeling.»
«In the second Bush Administration, they introduced what they call the chained, or C-CPI-U, as an alternate CPI measure. And this measure, the C-CPI-U, is a direct measure of the substitution effect. It is running a half a percent-to a percent below the official CPI -- which itself is running, oh, about 2.7% below where it was before the weighting changes were made in the Clinton Administration. All in all, if you were to peel back changes that were made in the CPI going back to the Carter years, you'd see that the CPI would now be 3.5%-4% higher. The difference that it makes is significant: if the same CPI were used today as was used when Jimmy Carter was President, Social Security checks would be 70% higher.»

He has an excellent discussion of CPI biases and hedonic adjustments.

But it is summarized reasonably by a previous comment:

«Today every disability case living in a flea bag hotel has both color TV and a better reciever. But they are still welfare cases living in flea bags and still cannot afford to get their teeth fixed.»

My conspiracy theory is that the CPI adjusters belong to the group of those who have realized that in order to sort out the USA's debt etc. mess what is needed is a period of high and prolonged inflation like in the 70s, and for this to have effect there must be no expectation among the public of it happening, and thus every opportunity must be taken to delay the realization that inflation is creeping up.

[skip]

Link fix needed - there's an "S" missing in the noyoyoeconomics link.

[shander]

What percentage of income has shifted from goods to services and does the CPI basket reflect this?

In 1850 some huge percentage of the workforce was involved in growing food, where its what, 1% today?. In 1950 maybe manufactured goods hit their high point. I would think that services like haircuts, plumbing repair, and the huge number of previously un-treatable things now treatable by healtcare (and subsequently more elderly people requiring more health care and services like pluming and haircuts, which they can't produce their fair share of).

[joan]

Why not look at ratios of the nomimal total income going to the bottom 60% or 80% to nomimal gdp. It might not look as bad as the numbers for the poor, but the results are still shocking and it is a number voters will apply to themselves. The argument that people may or may not be better off is essentially about utility which has no objective measure. The same people that are saying the snowblowers make you better off, will not admit the an extra dollar is worth more to a person earning $30,000 than to one earning $300,000. The point is not if Americans are better off but are they as well off as they could be.

[Jared Bernstein]

I like Joan's last point a lot. Simply asking whether real incomes are up, even at the median, is too low a benchmark. And while we all applaud the many improvements to living standards, such improvements have been ongoing for ever. Has their pace accelerated? I don't know. Probably in health care it has, but penicillin and antibiotics were major advances from years back.

BTW, folks might find Figure A from this paper http://www.epi.org/content.cfm/ib223 useful in the context of this debate—shows a long-term secular shift in expenditure weights from goods (where prices are rising less quickly) to services (visa versa).

If folks want to read my complete posting from which Brad kindly excerpted, go here: http://maxspeak.org/mt/archives/002542.html#more (and thanks, skip—I asked Max to fix the link. It should be www.noyoyoeconomics.com).

[Rich C]

As someone who has stubbornly argued for quite a while that middle class incomes in the US have been stagnating for 20, then 25, then 30 years, I want to put in a good word for arguing about the last 3 plus decades. I know, I know, you don't need to make the claim that average incomes or average wages have stagnated (let alone declined) in order to persuade people that social democratic changes would be good for the US, or that inequality is a problem.

But I think that it is worth pointing out that whenever folks on the liberal-left start talking about inequality (either directly measured or in terms of average wages vs. productivity), we are invariably confronted with the claim that inequality in and of itself is not problematic, so long as everybody's income is increasing.

Additionally, conservatives will always argue that social democratic changes will impede future economic growth; in essense, that the US economy has done great without that awful European stuff, so why put our economic strength at risk? Brad's suggestion that an "unbiased" CPI would ground claims for greater social democarcy seems to me to entirely miss this second line of conservative counter-argument.

My point is that it is politically naive to think that you can avoid a discussion of the US's past economic performance if what you are advocating is changes to US economic institutions. Logically, if past performance was terrific (or at least nothing to complain about) the argument for changing the institutions that gave rise to that performance is substantially weakened. On the other hand, when you can show that this performance has been dismal for that vast majority of Americans (which is, after all, what the 30 years argument is about), then you've got the potential to get somewhere.

I'm glad I got that off my chest. In closing I want to pose a puzzle. CPI-bias issues not withstanding, there is a widespread agreement that median earnings for white guys without a college degree have lagged GDP and productivity growth far more so than the earnings of any other group in the US for the last 35 years. Maybe they've stagnated, maybe they've declined a little, maybe they've increased only not by as much as everyone else's. The point though, is that whatever the absolute situation, the relative situation has been that white guys without college degrees are the laggards.

Now, there is also widespread agreement among the liberal left as to why this group has endured relatively poor earnings growth: deunionization, deindustrialization, rising education premiums, global competition, erosion of social insurance, etc. So here's the puzzle - even slightly before this relative decline took hold, this group - white guys without a college degree - had switched from somewhere between being consistently Democratic voters/ splitting their tickets to being consistently Republican voters. Indeed, except when Ross Perot was on the ballot, white guys without a college degree have been favoring GOP presidential candidates by at least a 20 % point gap. If anything, this gap has grown over the last three plus decades.

And yet, the economic well being of this group in particular seems to have suffered more than any other - this group that is the electoral bedrock of GOP power. Doesn't that seem weird? How sustainable could this be? If you didn't know the specific details of the US situation, and someone described this scenerio to you, how long would you guess that a party could sustain itself in power pursuing policies that undermined the economic standing and well-being of their key constituency, before that constituency's support for the party eroded? Can anyone think of a comparable example from the past or from another country?

[joan]

Rich c
You are making the assumption that the democrats are good or at least a lot better for white guys without college degrees on economic issues. I don't think there has been enough difference in economic policies beween the parties to out weigh the social issues.

[Jared Bernstein]

Rich C,

I hear you. Our book State of Working America is precisely targeted at that debate/discussion: the long-term economic challenges facing working families. In my longer piece (posted at Maxspeak) on the NYT article I wrote:

"... it’s clear that the typical male worker, while surely facing the many advantages associated with life today noted in Leonhardt’s piece, also faces a much tougher job market today than 30 years ago. The quality of jobs available to non-college-educated men has deteriorated. Such jobs are more likely to be in non-unionized sectors, with lower compensation, and they are less likely to provide health-care or pension coverage. Unemployment is also considerably higher and employment rates lower for such men now than three decades ago."

But it seems to me that the median voter--the person who decides elections these days--is much less likely to be responsive or interested in the discussion you raise, relative to one focuses on the recent past.

My sense and my reading of the polls is that blue and red-staters alike are feeling more economically insecure and are looking for ideas to meet the challenges they face, from hth care to globalization to stagant income growth amidst plenty.

You might get their attention with a resonant story about trends over the last 30 years but I doubt it.

[Sameer Parekh]

Most of the drop in snow blowers' prices took place before the middle class began to buy them. This drop provided a gain to those who already were buying snow blowers, but it provided zero gain to those who found them too expensive to be worth their money....

'zero gain'? So if I couldn't afford to buy a snowblower yesterday, and had to shovel my driveway by hand, whereas now I -can- afford to buy a snowblower, and I don't have to shovel my driveway by hand, I haven't gained anything?

(Of course I don't have to shovel my driveway, ever. I live in Arizona!)

[Ryan Fuller]

Of course not, Sameer, because you still can't afford dental care. Apparently that's how the argument goes. Only the criteria that the socialists care about matters. Your life sucks, because they say so.

Has the blue-collar American worker become more productive in the past thirty years? Yes, because of increases in capital accumulation and business efficiency; two factors that the blue-collar worker has nothing to do with. He's still pushing a button at a predetermined time, or making sure one piece of metal is welded properly onto another, or doing the same sort of quality control job that workers were doing decades ago. The groups that are becoming more productive (college educated professionals, enterpreneurs, etc) are seeing increases in the money they take home, while those who are doing the same things they've always done aren't seeing wage increases, although they benefit from the wider availability of goods that other people's productivity gains have brought about.

So here's my question: why are the socialists assuming that workers should be seeing wage increases if the work they're doing isn't getting better? Perhaps idealizing envy clouds one's thinking?

[sammler]

Provisionally accepting the premise of the commenters above: perhaps the question to ask is, "What is wrong with the Democratic Party, to such an extent that the median voter will defy his own best interests to support it?"

[dj superflat]

warning -- gross stereotyping ahead, but only in response to the gross stereotyping to which i'm responding:

redistribution sounds good in theory. but even uneducated folk have a pretty good sense that gov't isn't particularly good at spending money efficiently or wisely, or very good at doing much other than going to war (trips to the DMV may not be representative of what gov't can or can't do, but many take them as such). so they quite sensibly oppose sending a greater portion of what little money they may have to a gov't that will spend it on pet projects for various senators in their homestates or whatever that really do nothing to help out our uneducated worker. put another way, is there really any reason for a white, non-college educated worker in the south to think the democrats are going to do anything to help his plight (if it can fairly be framed as such)? if he listens to the democrats at all, he knows he's last in line for whatever goodies there are to be handed out. and he also knows the democrats don't have some great redistributive plan in the offing regardless, instead offering pretty much what the republicans do with some minor tweaks. so he votes for the party that lets him keep his gun, supports his church, etc. i can't see any real mystery. instead, it seems entirely rational. it also seems to fit with a quasi-mythic we all pull our own weight american mentality, whereby grossly different tax burdens just seem wrong, regardless of whether you think you'll ultimately make it rich (even if you almost certainly won't).

[joan]

Rich C " Can anyone think of a comparable example from the past or from another country?"
Midwestern farmers, around the time of the civil war, sided with the anti-slavery pro-tariff party instead of with the free trading south. In theory their economic self interest was served best by free trade.

[Bill]

Apropos of Jared Bernstein's comments on snowblowers-Didn't the drop in snowblower prices harm the rich guys who'd already bought them at higher prices, both by decreasing the residual value of their property and, from a prestige standpoint, by making their possession less of a status symbol? The guy who bought the last expensive one must have felt really stupid.

[Blissex]

«inequality in and of itself is not problematic, so long as everybody's income is increasing.»

But that is a very anti-American attitude, to do more with oligarchies like Soviet Russia or the British Empire. America has fought against both!

Any good American free capitalist wants more, wants a bigger piece of the pie, and if someone else is doing well, they want a piece of that action.

Can you imagine the CEO of GM saying to shareholders ''Sure, Toyota is doing a lot better than us, but we are uncomfortable making envy a basis of our business. Good luck to Toyota for making so much money, as to GM, we think it is better to just be happy with what we got''?

When the Chambers of Commerce and big corporates and the Business Roundtable open their wallets to K Street to get favourable legislation at the expense of taxpayers and their shareholders, customers, suppliers and competitors, they are just doing the traditional American thing: making more money by getting more leverage.

I would say that not looking with greed at what others are making and giving up trying to get a bigger slice of the pie is a socialist and defeatist un-American point of view.

[Sebastian Holsclaw]

"Any good American free capitalist wants more, wants a bigger piece of the pie, and if someone else is doing well, they want a piece of that action.

Can you imagine the CEO of GM saying to shareholders ''Sure, Toyota is doing a lot better than us, but we are uncomfortable making envy a basis of our business. Good luck to Toyota for making so much money, as to GM, we think it is better to just be happy with what we got''?"

But what is the solution? Is the solution for the government to tax Toyota and give GM the money, or is the solution for GM to work harder and make better cars so that consumers want to buy the GM cars more than the Toyota cars?

"My point is that American labor below 50 percentile income wants an equal share of the income growth that the CPI -- DOES -- measure as well as the free gifts of technology."

Of course they want that. The question is, as in the GM case above, whether or not society will require anything from them in order for that to happen.

[Kaleberg]

1) If I remember correctly there is an arcane economic concept that is germane to this discussion. It is called elasticity, and it states, in part, that some things are more important to consumers than others. Consumers will almost always buy food and shelter. If they have enough food and shelter, they might consider buying a snow blower, even if giving up shoveling snow makes it more likely that they contract diabetes or become prone to heart failure. Very few people who are reduced to living on the street and eating at soup kitchens buy snow blowers.

Any hedonic adjustment has to take into account the elasticity of the item, and it has to take into account the weighted elasticity based on the income and asset distribution. If everyone can reasonably afford a yacht, then a drop in yacht prices lowers the CPI. If no one can afford yachts, then a drop in yacht prices has no effect. I agree, that this is not obvious, and having to account for the fact that different people have different amounts of money makes computing the CPI harder.

2) Another arcane matter is that very few people are born with all the dollars they will ever need. Most people will have to spend a certain amount of time working to acquire the dollars that they need to buy things, so most people actually spend hours, not dollars. Like Anthony Rockwall, I like money as much as anyone, but I like money because of what I can buy with it, not for some mystical reason. A CPI computed in terms of dollars makes no more sense than multiplying the dimensions of a room in centimeters and declaring the result the area in square feet.

Thirty years ago single worker families with children were common. Thirty years ago forty hour work weeks were common. Neither of these are as common today.

Food and manufactured goods are cheaper than ever, but shelter is much more expensive. Remember, real estate is about location. People buy neighborhoods, not houses, and good neighborhoods are much more expensive than they used to be. Now, one has to buy more house to get the same neighborhood. A bad economist would adjust the CPI downwards, arguing that having to buy more house is good. A good economist would adjust the CPI upwards, arguing that having to buy more house is bad. If that makes me a Susanka fan, the so be it.

[Dean Baker]

Since there seems to be some confusion here on the snowblower point, maybe a small clarification would be useful.

If people don't buy a product, then they are telling us that it is not worth the price to them. In other words, their money is better spent on other things. All the people who did not buy a snowblower until the price fell to $100 were telling us that the snowblower was not worth more than $100 to them. The fact that a good, that they did not consider worth consuming, fell in price, gives them no gain in living standards. (How much does it help a person who keeps strictly kosher if the price of pork falls 90 percent? That is the story you should have in your mind.)The consumer only experiences any gains when a product that is already in his consumption bundle falls in price.

By the way, I would question whether the last quarter century has led to more rapid progress in health care in terms of outcomes. The development of the polio vaccine was huge and a bit further back we had the development of penicillin, an even bigger deal. The relevant question is outcomes, not gadgets.

[Steven Bass]

"The consumer only experiences any gains when a product that is already in his consumption bundle falls in price."

That's just not true though. A consumer experiences gains when a product that wasn't in his consumption basket falls in price enough so that he feels it is now beneficial to buy. I will benefit greatly from the continued fall of plasma screens even though they're currently too expensive for me to buy.

The fact that a consumer purchases something at a lower price proves that they're better off than when the good was at a higher price and they chose not to. At the lower price, the consumer still has the choice not to buy, the lower price has just increased the set of opportunities.

[Wlane]

One reason the low educated white males did so well 30 years ago was that they were the beneficiaries of prejudice against non-whites and non-males. The low-ed WM's got all the low skill high paying jobs. Now there's less prejudice and those type jobs must be shared more widely. Which party was more responsible for this turn of events? Which party do these WM's not feel at home with?