Category Archives: Markets

Quality Adjusted CPI Saved the Federal Government at least $150 Billion from 1998-2012

Cost-of-living adjustments increase entitlement spending automatically every year. Most COLA’s use all or part of the CPI to calculate inflation. The US further embeds the CPI in the system by indexing a growing portion of its government debt via TIPs. Even welfare benefits like food stamps use applicable indices within the all-items CPI to calculate COLA.

In total almost $3 trillion of federal yearly liability is subject to automatic annual CPI-based increases. This calculation includes:

  • All yearly means-tested welfare benefits subject to a COLA (e.g. SNAP, NSLP, etc…)
  • All yearly social security spending (e.g. SSI, OASI, DI, everything…)
  • All outstanding TIPs balance (every year the principal of an outstanding TIP is adjusted up/down by the inflation rate)
sources: http://budget.house.gov/uploadedfiles/rectortestimony04172012.pdf http://www.ssa.gov/policy/docs/statcomps/supplement/index.html http://www.gpo.gov/fdsys/pkg/ERP-2012/xls/ERP-2012-table87.xls
sources: http://budget.house.gov/uploadedfiles/rectortestimony04172012.pdf
http://www.ssa.gov/policy/docs/statcomps/supplement/index.html
http://www.gpo.gov/fdsys/pkg/ERP-2012/xls/ERP-2012-table87.xls

This time series represents the majority of yearly federal obligations that are subject to inflation-based COLA increases. We can thus attempt to calculate how much the government saved each year through methodological changes to the CPI. By the government’s own reckoning:

[The] improvements made by the BLS have reduced the measured
increase in the CPI… The combined effect of the changes made through 1998 has been to lower the CPI inflation rate by 0.44 percentage point per year. Changes to be implemented in 1999 and 2000 will lower CPI inflation by a further 0.20 and 0.04 percentage point per year.

– Economic Report of the President Feb 1999 pg 93

Thats a total of 0.68% a year from 2000 onward. While this might not sound like a lot, given the immense sums of money the government owes the public, this adds up to billions of dollars in savings:

applies 0.0068 deflation rate to total amount calculated above
applies deflation rate implied from report (0.0044 in 1998 up to 0.0068 in 2000) to total obligations calculated above

That adds up to a total savings of $150,147,988,800. Again, this is basing our deflation rate at 0.68% from the economic report referenced above. There is considerable evidence, however, that the real effect of quality adjustments on the CPI is much higher.

Using the more realistic divergence of 1-2% we saw from the BPP data puts the total savings at the $200-$400 billion range. 

In the investigation of any crime, it is important to find motive:

  • When a seemingly trivial change to a statistical index can potentially deprive taxpayers of hundreds of billions of dollars 
  • When an agency keeps raw data hidden from outside inspection (BLS deems raw pricing data as confidential and thus exempt from FOIA)
  • When a government cannot make the unpopular decisions necessary to reign in entitlement spending

Then you are in a time where an executive branch might take actions into its own hands in the name of efficiency. Hiding in econometric obscurity, in an area of research so boring no economist would dare tread, did the government knowingly encourage the adoption of a dubious economic theory that would likely bias inflation downward? If so, it was a good bet.

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Estimating the Effect of Hedonic Quality Adjustments on the Consumer Price Index

Having an informed debate over Hedonic Quality Adjustments is difficult due to the lack of comparable consumer price indices. A few exist, however, and today we will look at an index compiled by PriceStats, an off-shoot of MIT’s Billion Prices Project, which scrapes the internet for prices and compiles a daily index that aims to track inflation in real-time.

The time series eschews hedonic and seasonal adjustments and relies on sampling over 5 million products to produce a very different look at inflation (CPI included for comparison):

price_series

Since starting calculation of the index in mid-2008, PriceStats inflation series has remained consistently above the CPI as reported by the BLS. Considering the differences in methodology this provides an estimate to how much Hedonic Quality Adjustments have been used to understate the head-line CPI figures. Currently, the CPI uses quality adjustments on over 32% of the items used in its calculation. 

Annual inflation figures show a similar story, occasionally showing divergences greater than 1.5% in the two measures of annual inflation:

annual_series

In addition to being used as a benchmark for policymaker’s worldwide, CPI’s influence a myriad of payments:

  • calculating cost-of-living adjustments to social security and federal retirement programs,
  • calculating payments on over $700 billion worth of inflation protected securities (TIPs)
  • determining pay-bands in public and private entities
  • cost of living adjustments to collective bargaining agreements
  • determining IRS tax brackets and numerous tax-related levels (exemptions, for example)
  • Basic CPI indices feed into the PCE price index which is the preferred measure of inflation by the FOMC

Overall, CPI’s are used to index payments on over $10 trillion in liabilities. Any underestimation of  CPI benefits the federal government at the expense of the taxpayer and amounts to a backdoor default on its financial obligations. Please understand this could be deliberate or the result of dubious econometric methods. Using a bad model is like using a random number generator as a compass. 

To get an idea of the sums of money involved, for every 1% of CPI underestimation the federal government saves $8.4 billion on social security payments alone.  The lack of transparency regarding quality adjustments (and their perceived complexity) provides a perfect smoke-screen for covert debt management through CPI under-reporting.

There is no reason for this to be the case. Hedonic Quality Adjustments are computed via linear regressions, one of the least complicated models in statistics. Any statistician provided with the data could verify the BLS’s regressions using an off-the-shelf statistical computing package like R. Release the data, plain and simple; any other response smacks of corruption in the name of regression or an attempt to justify one’s existence.