The Bureau of Labor Statistics: Fixing the Consumer Price Index

I appreciate the opportunity to discuss CPI measurement issues. An accurate CPI is important. The subcommittee performs a valuable service by focussing attention on issues that are at once technically difficult even for professional economists and of vital concern for users of the index, including those in both public and private sectors. I have worked on CPI measurement issues as a researcher, and in my former capacities as Chief of the Price Index Research Division and Associate Commissioner for Research and Evaluation, both in the Bureau of Labor Statistics, and as Chief Economist in the Bureau of Economic Analysis.

January, 1998 CPI Weight Updating

In Januray, the Bureau of Labor Statistics (BLS) updated the Consumer Price Index (CPI) weights. They are now derived from consumption patterns for 1993-95. That clearly improves the CPI, because the weights are now more nearly current, compared with the pre-January index that used weights for 1982-84.

Moreover, BLS has indicated that in the future weights will be updated more frequently than the
ten to twelve year intervals of the past. Again, that is a positive step that will improve the CPI.
More could be done to reduce weighting effects, often called “substitution bias,” in the CPI.
Although the average substitution bias has not been large in the past (about 0.15 percentage
points annually), in some years it has gone as high as half a point (0.5). CPI changes to minimize
bias from out-of-date weights, discussed in the following paragraphs, may be worth their
additional cost.

BLS uses a fixed-basket formula (known as the Laspeyres formula) to aggregate 211 “strata
indexes,” such as the price index for “bananas” and the price index for “computer software and
accessories,” into the overall CPI. The fixed-basket formula takes no account of consumer
substitution–consumers shift spending toward those commodities that become relatively cheaper
(whose prices either fall, or rise less than average) and away from commodities whose prices rise
more rapidly. A price index formula that allows for consumer substitution provides a better
measure of the change in the cost of attaining a constant standard of living. Such a measure is
known as a “cost-of-living index.”