The Consumer Price Index Is Not Economic Reality
(Bloomberg Opinion) -- At 8:30 a.m. Eastern Time on Tuesday, the Bureau of Labor Statistics delivered its latest measure of inflation – the Consumer Price Index – with an aura of objectivity akin to the National Weather Service reporting the latest temperatures:
U.S. Consumer Prices Increased in March by Most Since 2012
Inflation Accelerated in March
Inflation Rate Rises as the Economy Reawakens
Lost in translation from bureaucratic spreadsheet to national talking point is an ugly truth: The CPI is no neutral measurement of economic reality. It has always existed as a creature of politics and power, revised and updated in ways that betray its image. How that came to pass is a cautionary tale told by historians like Thomas A. Stapleford.
In the 1890s, the federal government began collecting data on the cost of living and price levels in order to settle clashes in Washington over one of the era’s most contentious issues: tariffs. Democrats wanted to roll back levies that had succeeded in replenishing national coffers after the Civil War, while Republicans, many of whom represented domestic manufacturers fond of protectionism, succeeded in raising them.
Congress sought a data-driven solution to the standoff, asking the Bureau of Labor – then an independent department within the federal bureaucracy – to begin collecting statistics on wholesale and retail prices. Soon, the government was arguably pioneering the use of weighted averages to compile an overall price index. For example, if fuel consumed 20% of an average family’s expenditures while clothing only consumed 5%, any change in the price of these respective goods would be weighted according to their share of the total.
Unfortunately, Republicans and Democrats seized on different findings within these first indexes to advance their particular policies, shocking Carroll Wright, a statistician who served as the first commissioner of Labor. By 1895, Wright was second-guessing the entire initiative. “The difficulties surrounding the collection and classification of statistics relating to cost of production,” he wrote, “are so great in some directions as almost to render the statistical method ineffective.”
Still, he pressed on, releasing his first comprehensive report on prices in 1904 just as the economy contracted and wages fell. That led many Democrats who approvingly cited Wright in the 1890s to accuse him of fabricating statistics helpful to Republicans in an election year. Labor leaders later blamed his reports for understating rises in the cost of living as well.
When consumption patterns became an important measure of the success of Roosevelt’s New Deal, Labor Secretary Frances Perkins oversaw the creation of new “Cost-of-Living” index. It sought to acknowledge the shift to electric appliances and a host of other developments. It also expanded its focus beyond English-speaking, white, households headed by men – a serious bias in the earlier index.
The new numbers were more scientific than earlier versions. But as Stapleford notes, they required far more explanation, which meant that government economists found themselves in the position of turning their findings into policy recommendations. This increasingly put them in the position of shaping what were, in effect, political decisions. In the 1930s, many of these decisions revolved around a desire to increase working-class consumption – ideally, through higher wages secured by promoting collective bargaining.
World War II put the price index in service of very different political ends. As prices and wages soared in wartime, Roosevelt declared inflation the “enemy.” His administration promptly began using the CPI to justify caps on wage increases in order to keep prices from spiraling out of control. Unions cried foul, citing their own in-house economists to claim that the index was wildly understating inflation. The two sides fought an intense battle throughout the war, with labor generally on the losing side.
In the postwar era, big corporations like General Motors enshrined the new CPI in contracts negotiated with unions. Labor argued that it continued to understate inflationary pressures, while business leaders took the opposite view.
Business soon gained important allies: a group of economists who pushed to overhaul the CPI yet again, arguing that the CPI actually overstated inflation. They urged statisticians to capture the introduction of newer, cheaper goods and technologies that would counteract any rise in the prices of existing goods.
Neoclassical economists like George Stigler argued that it would be more accurate to define the price index in terms of “utility,” a term chosen to replace an even more nebulous word used by an earlier generation of like-minded economists: “satisfaction.” The idea was to break free of the fixed-basket approach to measuring prices by recognizing that consumers confronted by high prices of beef, for example, might readily shift to chicken.
A battle over defining the CPI played out for the rest of the century, with the constant-utility approach partially, though not completely, supplanting the older methods of determining prices. Despite the controversy and the fact that defining utility is an inherently subjective act, the CPI became one of the most important statistics in the land – and much more widely cited than the Personal Consumption Expenditures price index, which the Federal Reserve uses for inflation targeting.
During the War on Poverty in the 1960s, the CPI was used to define levels of welfare payments. Social Security payments soon fell under indexation as well, along with tax brackets – but not, oddly enough, the minimum wage. By the end of the 1980s, approximately half the federal budget was tethered directly or indirectly to the CPI.
Indeed, much of the debate about inflation over the past twenty-five years has revolved around attempts to create new measures of the CPI – especially so-called “Chained CPI” – that fully embrace constant-utility definitions.
Invariably, these measures show something that is always useful to one side or the other: lower rates of inflation than conventional indexes. Just as New Deal measures of CPI provided statistical ammunition for aiding the working class, chained CPI helps justify smaller annual increases in Social Security payments and other disbursements. It was also incorporated into the 2017 tax bill, insuring that as incomes rise, people move more quickly into higher tax brackets, increasing revenue.
The CPI methods may have their pros and cons, but they remain far more principled than the political arguments that embrace them. As President Biden and fellow Democrats open the spending spigots, Republicans will seek the inflation statistics that are best suited to close them.
The first architects of price indexes appreciated the degree to which these numbers are nothing more than vague approximations that, precisely because they rest on such shaky foundations, can be put toward political ends. Or as Carroll Wright uncharitably put it: “While figures will not lie, liars will figure.”
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg Opinion.
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