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CPI Is A Technical Fix, Let’s Keep It That Way
President Obama unveiled his budget yesterday and liberal groups have responded angrily to the inclusion of Chained-CPI in the proposal. A quick recap: currently Social Security benefits increase each year to keep pace with inflation according to the Consumer Price Index (CPI). The current calculation for inflation does not take into account that when the price of one product increases, people will switch to a lower-priced substitute instead of paying the higher price. The classic example is that when the price of beef rises, people buy more chicken and less meat, so the actual increase in the cost-of-living is not equal to the rise in the price of meat. Chained-CPI takes this into account. Since Chained-CPI is a low measure of inflation, Social Security benefits will grow at a slower rate. Thus, liberals argue that Chained-CPI is a benefit cut.
However, both CPI and chained-CPI estimate inflation for the average person. But Social Security beneficiaries are not average people. Most of them are elderly and much of their consumption comes in the form of health care and housing. Since health care and housing prices have risen faster than the rest of economy, the cost-of-living for seniors has increased at a quicker rate as well. That means that CPI and Chained-CPI both actually underestimate inflation for Social Security beneficiaries. Their benefits should actually rise quicker than inflation.
Nevertheless, much of the discussion right now centers on the fact that Chained-CPI is a benefit cut. The Washington Post‘s Dylan Matthews outlines everything I’ve said above and more, but finishes his piece by saying:
But ultimately, the question of which you prefer likely has more to do with whether you think Social Security benefits need to be pared back to ensure the program’s long-run solvency, or whether you think the elderly need, if anything, a benefit bump. Those are policy questions, not technical ones, and all the debate in the world about chained CPIs and CPI-Es relative methodological merits won’t resolve them.
Slate’s Matt Yglesias has a slightly better take:
As a technical matter, the best way to express this would be to start with the most accurate possible measurement of the price level (I might prefer the PCE deflator) and then inflate it by a fixed amount. But using a measurement of the price level that slightly overstates inflation works too.
If we want to have real benefits increases slowly each year for beneficiaries, then let’s use Yglesias’s technical fix. But, let’s start by getting the level of inflation right. CPI is not correct. Chained-CPI is also not correct. The closest measure right now may be CPI-E, but it’s still experimental and not ready for use.
In the end, I’m with Kevin Drum: let’s budget a small bit of money to research and develop a precise measure of inflation and then implement it. After that, we can start talking about inflating it by a fixed amount (as Yglesias advocates) or pairing benefits back altogether (as many Republicans advocate). First, though, let’s get it right.
The Graph That Made (Almost) Everyone Hate Deficits
Kevin Drum penned a post last night about why people hate deficits so much. He runs through a few options, but settles on the following:
Liberals have done an abysmal job of explaining why deficits are good during periods of high unemployment, so ordinary citizens have no reason to think deficits are anything other than bad.
I think this all hearkens back to the graph from Obama Administration economists Jared Bernstein and Christina Romer in January 2009 showing the expected unemployment rate with and without the stimulus. American Enterprise Institute’s James Pethokoukis has updated the graph with the actual unemployment rate (this is his update from September of last year):
It’s tough to prove that deficit spending in times of high unemployment works when the stimulus seems to have failed so badly. Of course, Bernstein and Romer’s graph was so far off because the economy was much weaker than anyone realized at the time, not because the stimulus failed (it didn’t). But, try telling that to your average person. For most people, that graph is confirmation that deficit spending does not work. That’s a very deep hole for liberals to start in.
Scott Sumner on Fiscal Stimulus
Yesterday, Scott Sumner penned a post arguing against liberals’ blind acceptance that the stimulus worked. He presents a counter factual arguing that if Congress hadn’t passed the stimulus, that the Fed would have stepped up and done more to offset the crisis. He argues that under that scenario, the economy would be in better shape now thanks to the Fed. At the very least, he says, liberals cannot claim that the stimulus worked without acknowledging his counter factual.
Fair enough. I’m with Matt Yglesisas here – economists agree that the stimulus worked, but are split on whether the benefits outweighed the costs. I’m not entirely sure how to evaluate Sumner’s counter factual. Is there any way to judge this? Are we forever left to wonder if the stimulus was the most effective policy or if, absent it, the economy would be in better shape due to the Fed? I wish there was an answer and I hesitate to offer one. I’m just a senior in college soon to have a degree in economics – nothing like Sumner or all the other economists who are unable to answer this question. Sumner’s theory is very interesting though and I’d love to hear a response from Paul Krugman, who has argued for quite a while that the stimulus succeeded.
One other point – at the end of his post, Sumner writes, “PS. Remember those Keynesians telling us that higher payroll taxes would slow retail sales in Q1? Looks like they might want to revise their models” and then quotes an article about how retails were way up in February. I’m going to offer a counter factual here: maybe retail sales would have been higher without the rise in payroll taxes and thus the higher payroll taxes did slow retail sails! I have no data or evidence for this – just as Sumner has no evidence that the Fed would’ve have done more and our current economy would be better if there was no stimulus. But both arguments are certainly plausible and worth exploring. Nevertheless, Sumner spends the majority of his post berating liberal economists who don’t consider Sumner’s counter factual only to make the exact same mistake himself. Nevertheless, a fascinating post and worth a read.
