59

surplus would be increased by a cumulative total of $16.5 billion over the 5-year period of

2004 through 2008.

Most of the impact of such a reduction in the CPI would be on federal outlays~such as
reduced payments to Social Security beneficiaries, which account for most of the outlays—
and most of the impact would occur in the later years. For example, according to
estimates by SSA actuaries using an annual 0.1 percentage point reduction in CPI growth,
the average monthly benefit check for retired workers in 2004 would be reduced by $0.91,
from $939.94 to $939.03; by the fifth year (2008), the average monthly check would be
reduced by $4.86, from $1,065.98 to $1,061.12.

BLS’ Response to Our
October 1997 Recommendation

In our October 1997 report, we recommended that as long as a fixed market basket CPI is
published, the Commissioner of BLS should update the expenditure weights of the CPI's
market basket of goods and services more frequently than every 10 years. BLS plans to
publish, starting in 2002, a CPI index based on the concept of superlative index formulas,
which would enable that index to be more current than the fixed market basket index in

reflecting consumer spending. The Boskin commission recommended use of a superlative

‘In our October 1997 report, we gave a 4-year CBO projection of $10.8 billion, which was
based on a March 1997 baseline. CBO used a March 1998 baseline to make the 5-year
projection.

8


123

Mr. SHays. Thank you very much.

Dr. Popkin.

Mr. PopKIN. Thank you, Mr. Chairman. I have a written state-
ment that I request be placed in the record. I will try to both com-
ment on what I heard this morning and work that into my own tes-
timony.

The first thing I’d like to note is that the discussion this morning
seemed to be characterized as sort of an academic, Government sta-
tistical agency, policymaker colloquy. I want to point out that I’m
a businessman, and I’m the president of an economic consulting
company that I established 20 years ago, and that one of the things
my clients ask me to do is to interpret, analyze, and forecast the
statistics the Government puts out. And for me to do my job I need
objective statistics that are as accurate as they can be. And as a
result of that, I have kept an active interest in what goes on in the
statistical system, and I follow the CPI issue very closely.

Like the other speakers on the panel, I don’t, most of my com-
ments are really forward looking not with respect, not so much
with respect to what’s already been done. We know the Council of
Economic Advisors, the changes the BLS have made have reduced
the annual inflation rate, or will reduce it by 1999 by seven-tenths
of 1 percent. I heard Katharine Abraham this morning say eight-
tenths of 1 percent. In any event, there’s been a substantial reduc-
tion in the rate of inflation apparently as measured and reported
by the BLS. There is—a good part of that comes from the substi-
tution bias and no one would disagree with the correction of the
CPI for substitution bias. I think that’s the part of the Boskin Com-
mission report that was widely accepted. The reason economists
say, and the Wall Street Journal reports, that almost three quar-
ters of the economists they pooled thought the Boskin estimate was
too high, the reason they thought that really had to do with the
quality estimate which I’ll get into at a later issue.

But of all the issues that must be addressed if the CPI is to be
a better proxy for the cost of living, correction for substitution bias
is, perhaps unfortunately, the easiest. That’s why it could be ac-
complished most quickly. But it’s unfortunate because what it real-
ly means is that the BLS has corrected for the overstatement first,
so the potential understatement bias is posed by moving the CPI
to a cost-of-living index remain and there are fewer upward-bias
elements to offset them.

I think, Mr. Chairman, you addressed that this morning when
you asked the question, “What are downward biases in the index?”
And I think there are some and because the way this has worked
out with the downward—the upward biases have been corrected
first, I think that makes all the more urgent the need to move for-
ward to correct some of the downward biases.

Now, one of the downward biases that is, really can be corrected
right now and no one addressed it today. In 1971 when I was in
charge of the CPI, I recommended that the environment be treated,
environmentally opposed costs like a catalytic converter on a car be
treated as a price increase, not a quality change. My boss bought
it. Someone far above questioned it, and it got reversed. And the
BLS has treated that kind of thing as a quality change, not a price
increase as I think it should be treated ever since.


25

basket of goods and services, such as the CPI now does, represents an upper bound on changes in
the true cost of living. I doubt there exists a professor teaching microeconomics who doesn't _
routinely demonstrate this characteristic of fixed-weight price indexes to his or her classes. The
reason is that consumers respond to changes in relative prices by altering the composition of their
purchases, and this response lowers the cost to them of the price changes.

Consider a couple of examples. If chicken goes on sale, some consumers would buy
more chicken and less beef or pork. Also, as computer prices have fallen dramatically in recent
years, consumers have increased their purchases of computers. At present, however, the market
basket used in constructing the CPI changes only once every ten years. Although BLS has just
updated this market basket, the current methodology for the CPI will lock this market basket in
place for the next decade, implying that consumers are assumed not to do any substitution at all
over this period. Under these procedures, the CPI will fail to capture the ways in which
consumers adjust their spending pattems to take advantage of changes in relative prices.

We should distinguish between two levels of substitution bias. In the discussion here, I
am focusing on what has been termed “upper-level” substitution bias. Based on surveys of what
consumers buy, the BLS has a list of 211 items in the typical consumers’ market basket. Upper-
level substitution bias arises from substitution among these items that is not captured by the CPI,
such as between chicken and beef or between breakfast cereal and other breakfast items. In
addition, consumers also make substitutions among different varieties of the same item in their
market baskets, such as when consumers switch between different brands of breakfast cereal. By

early 1999, the BLS will have largely accounted for this “lower-level” substitution when it

3.


COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT
DAN BURTON, Indiana, Chairman

BENJAMIN A. GILMAN, New York HENRY A. WAXMAN, California
J. DENNIS HASTERT, Illinois TOM LANTOS, California
CONSTANCE A. MORELLA, Maryland ROBERT E. WISE, Jr., West Virginia
CHRISTOPHER SHAYS, Connecticut MAJOR R. OWENS, New York
CHRISTOPHER COX, California EDOLPHUS TOWNS, New York
ILEANA ROS-LEHTINEN, Florida PAUL E. KANJORSKI, Pennsylvania
JOHN M. MCHUGH, New York GARY A. CONDIT, California
STEPHEN HORN, California CAROLYN B. MALONEY, New York
JOHN L. MICA, Florida THOMAS M. BARRETT, Wisconsin
THOMAS M. DAVIS, Virginia ELEANOR HOLMES NORTON, Washington,
DAVID M. McINTOSH, Indiana Dc
MARK E. SOUDER, Indiana CHAKA FATTAH, Pennsylvania
JOE SCARBOROUGH, Florida ELIJAH E. CUMMINGS, Maryland
JOHN B. SHADEGG, Arizona DENNIS J. KUCINICH, Ohio
STEVEN C. LaTOURETTE, Ohio ROD R. BLAGOJEVICH, Illinois
MARSHALL “MARK” SANFORD, South DANNY K. DAVIS, Illinois
Carolina JOHN F. TIERNEY, Massachusetts
JOHN E, SUNUNU, New Hampshire JIM TURNER, Texas
PETE SESSIONS, Texas THOMAS H. ALLEN, Maine
MICHAEL PAPPAS, New Jersey HAROLD E. FORD, Jr., Tennessee
VINCE SNOWBARGER, Kansas —
BOB BARR, Georgia BERNARD SANDERS, Vermont
DAN MILLER, Florida (Independent!

Kevin BINGER, Staff Director
DaxtEL R MOLL, Deputy Stoff Director
Wittiam MOSCHELLA, Deputy Counsel and Parliamentarian
dJuort McCoy, Chief Clerk
Put. SCHILIRO, Minority Staff Director

SUBCOMMITTEE ON HUMAN RESOURCES,
CHRISTOPHER SHAYS, Connecticut, Chairman

VINCE SNOWBARGER, Kansas EDOLPHUS TOWNS, New York
BENJAMIN A. GILMAN, New York THOMAS H. ALLEN, Maine
DAVID M. McINTOSH, Indiana TOM LANTOS, California
MARK E. SOUDER, Indiana BERNARD SANDERS, Vermont (Ind.)
MICHAEL PAPPAS, New Jersey THOMAS M. BARRETT, Wisconsin
—— —— DENNIS J. KUCINICH, Ohio

EX OFFICIO
DAN BURTON, Indiana HENRY A. WAXMAN, California

LAWRENCE J. HALLORAN, Staff Director and Counsel
ROBERT NEWMAN, Professional Staff Member
JESSE S. BUSHMAN, Clerk
CHERRI BRANSON, Minority Counsel

ap


119

The BLS should establish a new index that is published and updated annually, and
revised historically as far back as possible. The index should immediately take into account all of
the changes made to the CPI since 1990 and any future improvements that are made to the
official CPI. This new index could then be used -- much like the current CPI-U-X1 index —as a
deflator in economic research.

Conclusion:

‘A major problem is not the CPI itself, but what itis used for. Although Congress explicitly
intended to automatically insulate program beneficiaries and taxpayers from the effects of inflation,
they chose a mechanical process that does not accurately account for changes in the true cost-of-
living, The Secretary of Labor and the BLS can and should make improvements to the CPI.
Congress must conduct effective oversight and make it a priority to keep such an index up to date.
Even if the upward bias in the CPI is only a fraction of a percentage point per year, the relentless
compounding of such a bias ultimately has significant budgetary consequences.

Thank you very much for your time. I will be happy to answer any questions that you
may have.


68

However, BLS’ performance plan does not fully portray how BLS' strategies and resources
will help achieve the BLS performance goals. We believe such information would better
enable CPI stakeholders to see how BLS intends to achieve each goal and the associated
resources it will need to do so. BLS’ performance plan does link each performance goal
aimed at improving the quality of the CPI with BLS' program activities listed in the
President's budget and shows the increased amount of funding and full-time equivalent
staff associated with achieving all such goals. However, BLS’ performance plan does not
show the funding level associated with the individual program activities identified in its

performance plan, as provided in OMB's Results Act guidance.

Finally, under the criteria in the Results Act and related guidance, agencies should
describe the means to be used to verify and validate performance data. According to this
guidance, the means used should be credible and specific to ensure that performance
information is sufficiently complete, accurate, and consistent. BLS' performance plan for
fiscal year 1999 does not specify the procedures BLS intends to use to verify and validate
the information related to its performance goals for improving CPI quality. However, in
its performance plan for fiscal year 1999, BLS states that over time it will validate its
indicators by showing how they relate to desired outcomes, such as improving accuracy.
In addition, we believe it would be more useful to CPI stakeholders if the plan included
information to demonstrate the credibility of the data BLS will use to measure its

performance.


79

I ask? So it’s not just—in other words, a lowering of the CPI, for
whatever reason, would reduce Government spending. And 60 per-
cent of the impact is on spending and 40 percent is on increased
taxes because we don’t change the index for the tax rate so you
don’t arbitrarily go into the next tax rate. Is anyone prepared to
tell me if that’s accurate or not?

Ms. ABRAHAM. That’s not something I can address. Clearly, slow-
ing the rate of growth of the CPI would impact both but we
don’t—-

Mr. Suays. You don’t know the—OK.

Ms. ABRAHAM [continuing]. Produce estimates of the magnitude.
The Congressional Budget Office——

Mr. SHays. OK.

Ms. ABRAHAM [continuing]. Has looked at that.

Mr. SHays. Yes, sir?

Mr. Gorpon. There are figures on that in the commission report.
It looks to me it’s more like 35 percent on revenues, about 50 per-
cent expenditures and the rest of it comes on reduced debt service,
reduced interest.

Mr. Suays. OK, interesting.

Mr. Gorpon, So I would say, it’s 50, 35, and 15 is about right.

Mr. Suays. Great. I didn’t even think of it in terms of debt serv-
ice. In terms of your presentation, when you talk of the currency,
you're talking of timeliness of the data?

Ms. ABRAHAM. I'm talking about the period of time to which the
market basket that we're using to construct weights for the index
applies.

Mr. SHays. We changed the bread basket, it was in the 1980's
and you brought it up to the 1990’s somewhat, 1993 to 1995.

Ms. ABRAHAM. 1993 to 1995.

Mr. Suays. What is the intention of BLS in terms of how often
that bread basket gets changed?

Ms. ABRAHAM. We have not, at this point, made a specific deter-
mination. We have said that we will do it more often than every
10 years. I would guess that the most likely frequency of updating
would probably be every 5 years, but we’ve not made a specific de-
cision on that.

Mr. SHays. The recommendation of GAO, is that it be more like
5 years instead of every 10 years, is that correct?

Mr. UNGaR. Mr. Chairman, we said more frequently. We didn’t
have a specific number in mind. | believe the research isn’t very
definitive there. Many people believe that 5 years would be appro-
priate, but the data aren’t really conclusive on this point.

Mr. SHays. When I refer to the bread basket, I do mean the mar-
ket basket.

Mr. Uncak. Right.

Mr. Says. I saw some confused faces. I'd like all of you to re-
spond to it because for me it seems like a “no-brainer.” I guess be-
cause I don’t know the extent to which it involves—I mean, to me
it seems fairly simple. You just continually want to update that
market basket.

Ms. ABRAHAM. If I could and then——

Mr. SHays. Yes.


15

current CPI formula, we have decided to implement the
geometric mean estimator in most CPI basic indexes. The
changes we will be making were announced on April 16, and,
as originally planned, will become effective with data for

January 1999,

The geometric mean estimator will be used in index
categories that comprise approximately 61 percent of total
consumer spending represented by the CPI-U and 64 percent
of that represented by the CPI-W. The remaining index
categories, which are shown on the attached table, will
continue to be calculated as they are currently. Based
upon BLS research, it is expected that adoption of the new
formula will reduce the annual rate of increase in the CPI

by approximately 0.2 percentage point per year.

Finally, Mr. Chairman, I would like to turn to the last
question posed in your letter, which I believe was aimed
principally at ascertaining our future plans and the
resources required to implement those plans. In this
regard, I would like to call your attention to the BLS
Congressional Budget request for Fiscal Year 1999, in which
we are seeking to build upon an initiative, started in

1998, to lay the groundwork for future improvements in the


128

In its most recent report, the President's Council of Economic Advisers has estimated that
improvements made through 1997 and those slated for 1998 and 1999 will reduce the annual rate
of increase in the CPI by seven-tenths of one percent (0.28 + 0.41 percentage points), All but one

of the improvements, in place and to be put in place, have lowered the measured inflation rate.

Of the seven-tenths total reduction, the two largest contributors, accounting for almost half,
have to do in some way with correcting for so-called substitution bias. All economists would, at
least in theory, support the view that such a correction is appropriate if the CPI is to represent
changes in the cost of living. ‘The Boskin Report put substitution bias at 0.5 percentage points, but
that estimate has been shown to double count some substitution effects.’ So the new formulas the
BLS has adopted to address substitution have just about remedied the problem, at least as quantified

by the Boskin report.

‘The other 0.6 percent of the 1.1 percentage point bias reported in the Boskin panel report
is the contentious part. A Wall Street Journal survey, published February 25, 1997, after the
release of the Boskin report, found that over 70 percent of the 320 economists surveyed had smaller
estimates of CPI bias. ‘That view most likely reflects the skepticism about the quality and new
goods estimates put forth by the Boskin panel, which account for the other 0.6 percent, rather than

skepticism about substitution.

'See statement of BLS at hearings of the House Budget Committee, April 28, 1995.


134

Mr. SHAysS. Proposals from what you’ve done. Yes, we have cov-
ered some of this territory maybe not as concisely as I would like
in the earlier panel. But this is, 1 think an issue that both the
ranking member and I are kind of wrestling with. We basically de-
termine the CPI for a particular family, and that income level is
more than $75,000 in this sense. Give me the percent because I’m
going to nail that down, and maybe we can adjust that for the
record. You said it was at?

Mr. PopKIN. Seventy-five.

Mr. Suays. Yes, OK. The thing that fascinates me is if I’m a fair-
ly poor person, I’m going to pay my rent, I'm going to buy my food,
and I’m going to try to get clothes for myself and for my kids. And,
you know, I'd love extra activities like being able to go to a movie
and so on. But I also want that car, and the car is not going to
be new. So I’m going to get a second-hand car, not a new car. I’m
not going to realize the benefits of some of the newness. But I’m
going to still have to get that darn auto insurance. So when you
figure out the auto insurance in terms of the market basket, you
are making a determination that it’s only a certain percent of my
income, 75th percentile. And, in fact, it’s a much bigger part of my
income, and so, I just see a gigantic distortion because if that goes
up significantly I’m impacted very negatively.

Mr. Popkin. That’s right. That’s sort of a fixed cost. It goes with
the territory.

Mr. SHAYS. Yes, it is a fixed cost.

Mr. PopKIN. Right.

Mr. Says. I don’t have much substitution. Really what I’d prob-
ably do is what, excuse me, I wouldn’t think of doing this, but what
some people probably do, is they probably at some point drop their
auto insurance. They literally drive without auto insurance.

Mr. PopKIN. You know this is very topical in another sphere
which is the recreational vehicles. If you make the assumption that
recreational vehicles are very expensive, and only bought by people
in the upper 25 percent of the income distribution, and the insur-
ance companies keep a level, but they create more damage.

Mr. Suays. Right.

Mr. PopKIN. But the insurance companies keep their premiums
level, they’re essentially imposing more of the insurance burden on
the lower income families who are driving the small cars.

Mr. Wizson. Mr. Chairman, I’d like—two points I'd like to make.
One is the consumer expenditure survey currently collects family
income data. They ask that in terms of keeping the diary in what
you spend your income on. And they ask, “how much is your family
income?” And that, so——

Mr. Suays. Let me ask you this——

Mr. WILSON. It’s made fairly easy with the expansion——

Mr. Suays. Let me interrupt you a second. You're saying that
when they do interview these families, they’ve asked them to keep
a record?

Mr. Witson. They keep a diary. There’s an interview and there’s
also a diary.

Mr. Suays. But do they pay them to keep that diary?

Mr. TRIPLETT. No, it’s voluntary.


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32

lawnmowers run more cleanly and efficiently. So quality change is
quite pervasive and, indeed, some of it is very hard to measure.

Probably swamping the importance of unmeasured quality im-
provements is the most important omission from our estimate of
the overall bias in the CPI and that is the value contributed by
new products. Here it’s important to distinguish two problems with
the CPI. The first is the late introduction of new goods. New prod-
ucts, like air conditioners, microwaves, and VCR’s, typically decline
in relative price early in their lifetimes after which relative prices
level off. In each of the cases I just mentioned, air conditioners,
microwaves, and VCR’s, the introduction into the CPI took place
many years after introduction on the marketplace. On average, say,
8 to 10 years late. So that much of this initial price decline was
simply missed.

The other dimension of new products is that consumers receive
value from their very invention. They like stereo sound better than
mono, they like color TV better than black and white, and so on.
And it’s the latter part, the consumer value of new products, that
we did not include at all in our estimate of the 1.1 percent bias.

There’s another piece of evidence that I’ve cited before and I can
update that for you. There’s an alternative measure of consumer
price inflation, produced by the Department of Commerce; called
the personal consumption deflator, and it uses all the ingredients
from the CPI. It’s affected by quality change for most of the CPI
categories. It’s affected by the substitution biases we’ve been dis-
cussing, yet it has different measures for medical care, airline
fares, and computers, at least until right at the moment. And to
update the number, the PC deflator has risen over the last 12
quarters at 0.5 percent less than the CPI despite all of the ele-
ments that it has in common with the CPI.

And in my written testimony, I go through a little calculation
and suggest that if you took the bias that remains in the PC
deflator and add that 0.5 percent difference, you'd get about 1.3 in-
stead of 1.1 as an estimate of bias in the CPI over that period. Now
that period is in the past, 1995-1997, and there have been a num-
ber of changes since.

Let me focus, at the end, on the—those of our recommendations
where the BLS has not yet committed itself, at least in public, and
suggest some of the things that Congress could help with.

There is no dispute with our first recommendation that the BLS
should attempt to implement the principle that the CPI is an index
of cost of living. But there has been no movement so far on our sec-
ond, and I think one of our most important recommendations, that
the BLS should produce a second index; Ed Gramlich has already
mentioned this, which we call the research base index, produced
only annually so there’s no confusion with the real time monthly
index, and subject to continual revision as new information be-
comes available either on weights, on quality change, or on the
value of new products.

Upper level substitution bias is another area where, as has al-
ready been mentioned, while the CPI has moved after a 10-year in-
terval to more up-to-date weights for aggregating these 211 cat-
egories, they have not committed themselves to an ongoing moving


103

Mr. Suays. Thank you, Dr. Gramlich. Dr. Abraham.

Ms. ABRAHAM. I, perhaps to my surprise, find myself thinking
that you put this about as well as I could.

Mr. SHays. “You” being who?

Ms. ABRAHAM. Bob Gordon. The CPI is a very timely measure.
The weights that we use in deciding how much importance to at-
tach to different prices have not been as current in the past as they
will be going forward. I’m in sympathy with, and we have indeed
said that we are pursuing, some of the things that we have talked
about in terms of updating rapidly changing segments of the index
more rapidly. I would hope, however, that the committee would not
lose sight of the fact that even before the recent round of changes
that were made in the CPI, this was a very good measure. There
is a lot of work that goes into ensuring that the prices we collect
are representative of what people are purchasing, that new items
and outlets are brought into the index and, again, even prior to the
changes that we introduced recently, I think the U.S. CPI would
compare very, very favorably to the CPI produced by any other
country. We obviously always can work to improve what we're
doing. We've done that and we'll continue to do it.

Mr. Suays. Yes, yes, Dr. Ungar, I’m sorry?

Mr. UNcar. Just not to be left out, Mr. Chairman, I will speak
on behalf of GAO. I think I would agree with Dr. Gordon and Dr.
Abraham that on the price issue that is done monthly that the cur-
rent, the weights again, as we pointed out, and everybody has
pointed out, we do believe that they could be more current. Right
now, they were just adjusted. However, in the future, we would cer-
tainly urge that more frequent updates than every 10 years would
be appropriate.

Mr. SHays. OK, thank you. I’m just going to conclude, and I'll
just skip to Mr. Towns. I represent a district of the wealthiest of
wealthy. I mean, truly, the wealthiest of the wealthy, and the poor-
est of the poor in that I represent three urban areas and so I have
a tremendous contrast. I take tremendous pride in what Congress
on both sides of the aisle, and the President, have been able to do
to get our country’s financial house in order. We’re moving in the
right direction. And I see that as a tremendous beneficial effect on
interest rates, the retirement funds of our workers, so I see a lot
of good things benefiting the American people in what’s happened.

d I do want to say to you, I know a lot of people have played
a role in that, but obviously the American people have played the
biggest role in terms of their energy and the progress we've made
with productivity as well. So, I know this is a very dynamic econ-
omy. I know it’s hard to keep up with, but we obviously need to
educate ourselves better on this side of the table, and that’s what
we're attempting to do.

Mr. Towns.

Mr. Towns. So, Mr. Chairman, you're not against the stock mar-
ket going up? [Laughter.]

Mr. Suays. I am thrilled that Americans are—I realize that we
need to be very cautious about its ultimate implications and make
sure that the enthusiasm doesn’t cloud our good judgment.

Mr. Towns. I agree with you, Mr. Chairman, and no question
about it. Let me, again, thank the members of the panel for coming


39

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 6

included in either our report nor taken into account in the CPI: a new refrigerator will
consume "at least $250 less in power over its lifetime” than older units; new dishwashers are
"much quieter and more frugal with power and water;" new front-loading washing machines
“are markedly more energy efficient than old models;" a new TV set in almost any size will
“offer more than the one it’s replacing;" new CD players "hold more discs than older ones;"
new gasoline lawn mowers "run more cleanly and efficiently.” Notably, there have been no
advances worth a remark on some other products, including washing machines, ranges,
dryers, VCRs, riding mowers, vacuum cleaners, and microwave ovens.

Probably swamping the importance of unmeasured quality improvements is our most
important omission, the value contributed by new products. Here it is important to
distinguish two problems with the CPI.

The first problem is the late introduction of new goods into the CPI. New products
like air conditioners, microwaves, and VCRs, typically decline in relative price early in their
history, after which prices level off. Clunky and unreliable VCRs were introduced in the
late 1970s at more than $1,000, soon to be replaced by electronic, programmable, and
reliable models with better recording and playback capabilities at $200. Most of this price
decline had already occurred when VCRs were finally introduced into the CPI in 1987 ~
by that year fully half of Ameitcan houscholds owned VCRs, and all of the price decline
they had experienced was simply omitted from the CPI. The cellular phone is a more
contemporary example — by some measures the prices of cellular phone service had declined

by 90 percent by the time the cellular phone was finally included in the CPI in January,


As you requested, we reviewed BLS’ performance plan for fiscal year 1999, focusing on
the plan's elements that related to the objective of improving the quality of the CPI. To
do this review, we used criteria in the Results Act, Office of Management and Budget's
(OMB) guidance on developing the plans (Circular A-L1, part 2), our February 1998
guidance for congressional review of the plans,” our April 1998 guidance for assessing
agencies annual performance plans,’ and the December 17, 1997, letter to OMB Director
Raines from eight congressional leaders that includes suggestions for how to make the
performance plans more useful. For purposes of our analysis, we collapsed the six
requirements for annual performance plans in the Results Act and the related guidance
into three core questions: (1) To what extent does the agency's performance plan provide
a clear picture of intended performance across the agency? (2) How well does the
performance plan discuss the strategies and resources the agency will use to achieve its
performance goals? (3) To what extent does the agency's performance plan provide

confidence that its performance information will be credible?

rm h
Facilitate Congressional Decisionmaking (GAO/GGD/AIMD 10.1.18, Feb. 1998).
“The Re s Act: An aluato ide to Assessing Agen: Ann P
(GAO/GGD-10.1.20, April 1998).

13


35

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 2

that the estimates for each of the categories was necessarily imprecise and established a range
of 0.8 t0 1.60 around our point estimate of 1.10 percent per year.

Much of the initial reaction centered on the implications of the Report for the
indexing of Social Security, the income tax system, and other programs. While our report
contained estimates of the implications of an upward bias in the CPI for the Federal budget,
both in the past and in the future, we did not make a specific recommendation on an
alternative formula for indexation but merely said that "the President and Congress must
decide.” In the event, the Congress did not take action to alter any indexation formula, and
time limits require me to skip over the portion of the debate about our report concerning
such issues as the creation of a separate CPI for the elderly or the complex conceptual issue
of whether an increase in life expectancy should be treated as a change in the cost of living
and would warrant a change in the current provision of Social Security benefits.

Instead, my focus today will be on the accuracy of the CPI itself independent of issues
involving how the CPI is used.’ It is important to stress from the outset that throughout the
development of the report and the aftermath, relations between the Commission members
and the BLS have been cordial and constructive. Much of the research we cite in forming
our estimates of bias was originally performed by BLS staff members. BLS officials were

open in their recognition that there were many problems in the CPI that needed to be

1. A detailed statement of the criticisms of the report and an extended response to them is contained
in Boskin et. al. (1998). A full reference to this article and many other references contained therein is
presented as an Appendix to this testimony. ‘The most detailed and accessible critiques of the report by
BLS officials are Moulton and Moses (1997) and Abraham, Greenlees, and Moulton (1998). My response
to the Moulton-Moses paper is contained in my printed discussion in the same source.



67

sample is: "Begin data collection and processing of larger sample." In its justification for
its submission for the President's budget, BLS requested resources to expand the sample
size of the CE by approximately 50 percent. The performance goal as set forth in the
annual plan is not as specific, however, and does not inform the reader that BLS plans to
expand the CE by 50 percent. Also, if the baseline measure cited the prior CE sample
size, which it does not do, then CPI stakeholders could determine whether BLS has
achieved its goal to expand the CE by 50 percent when it reports its results. We also
note that none of the performance goals to improve the quality of the CPI provide

baseline measures.

Under the criteria in the Results Act and related guidance, annual performance plans
should briefly describe the agencies’ strategies and the human, capital, financial, and
other resources they will use to achieve their performance goals. BLS' performance plan
indicates that state-of-the-art statistical techniques, economic concepts, technology, and
management processes will be applied to achieve its performance goals aimed at
improving the quality of the CPI. It also mentions the operational processes and
technological advances that BLS is making. Further, the plan points out that BLS is
requesting additional funding for fiscal year 1999 of about $9.1 million and 36 full-time
equivalent employees to undertake initiatives needed to improve the CPI's timeliness and

accuracy.

16


104

and sharing with us. I think that you have been very, very helpful
but, Mr. Chairman, I think that maybe we might need to have fur-
ther discussion to get some other information. So maybe we might
have to look at, at some point in time, having a third hearing on
this issue.

So, thank you very, very much, for coming and sharing.

Mr. SHays. My staff member said next April when you’re chair-
man. [Laughter.]

He didn’t say that last part. Strike that from the record. [Laugh-
ter.

Mr. Towns. I like the idea. [Laughter.]

Mr. SHays. But I didn’t say though as you became a Republican.
(Laughter. ]

Let me thank all of you and also thank the second panel that has
been waiting. Dr. Abraham, one of the ways we're going to deal
with this issue is our committee is going to stay in closer contact
with you, and to be more up to date, just on the staff level, as well,
and we appreciate your cooperation. We thank all of you for partici:
pating in this first panel. You have been more than patient in lis-
tening to our questions.

We'll call our second and last panel. Dr. Jack Triplett, visiting
fellow, Economic Studies Department, the Brookings Institution;
Dr. Mark Wilson, labor economist, the Heritage Foundation; Dr.
Joel Popkin, president, Joel Popkin and Co. We invite all three to
come to the dais, excuse me, to the table and we'll swear you in.

If the three of you would remain standing. Dr. Popkin, and Mr.
Triplett, why don’t you—Dr. Triplett should be put in the middle,
excuse me. We'll slide you over. Can you move those places over,
please? OK, here we go.

[Witnesses sworn.]

Mr. SHAyS. We swear in all of our witnesses, it’s an investigative
subcommittee, including Members of Congress, candidly, when they
come and seek to give testimony. I would really welcome your testi-
mony, and obviously it will be, your written testimony will be sub-
mitted in the record. I would be happy to have you respond to what
you've already heard as well, and not have to wait for the questions
on that. And, frankly, I’m happy to have you tell us if we’ve focused
on some issues we shouldn’t have and should have been focusin,
on some other issues. Neither the ranking member nor I will be of-
fended by your critiquing what we need to focus in on.

I called you in the order of Dr. Triplett then Dr.—Mr. Wilson,
and Dr. Popkin, and I'll go in that order, OK. Dr. Triplet.

STATEMENTS OF JACK TRIPLETT, VISITING FELLOW—ECO-
NOMIC STUDIES, THE BROOKINGS INSTITUTION; D. MARK
WILSON, LABOR ECONOMIST, THE HERITAGE FOUNDATION;
AND JOEL POPKIN, PRESIDENT, JOEL POPKIN AND CO.

Mr. TRIPLETT. Thank you. I appreciate the opportunity to appear
before this subcommittee and discuss CP] measurement issues. As
the subcommittee recognizes, the CPI is important. Price measure-
ment issues are difficult ones, even for professional economists, and
they're certainly issues that are of vital concerns to all users of the
CPI, both public and private.


126

an index that focuses on people around the median income dis-
tribution, they didn’t have the VCR when those prices were coming
down the curve at first. They only stepped in and started to buy
when those prices really got affordable for them.

Mr. Suays. Yes.

Mr. PoPKIN. So you didn’t lose, you were not contributing to up-
ward bias in the index if you were talking about the cost of living
for somebody at that percentile. So I think I would like to see the
BLS present a plan and Commissioner Abraham suggested that
they have done work on different families. I think it can be done
and I would put that as a high priority item.

I certainly commend the committee’s position vis-a-vis the BLS.
I think it’s important, it’s vital that the country feels that their sta-
tistics are not being politicized by any outside group. This is just
as Congress, you have their outsiders, too, who are coming in, and
you have to protect the BLS and do everything to keep the BLS as
an honest broker in looking at ideas, but having the final judg-
ment.

Mr. SHAys. But you even pointed out something, maybe unwit-
tingly, in your comments that there’s a debate within the Govern-
ment as to the impact, for instance, on the gross domestic product
and so on. So, there are lots of factors here and I guess it would
be naive for me not to realize that.

Mr. PoPKIN. Yes. So, I think those are my basic——

[The prepared statement of Mr. Popkin follows:]


45

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 12

Commission recommendations, its timid agenda for reform, and its lack of ambition in
setting a major challenge to itself and to Congress to work toward a Consumer Price Index

that would set a clear standard for statistical agencies around the world.


87

Mr. GRAMLICH. I am a Governor of the Federal Reserve. {Laugh-
ter.]

Mr. Suays. That's like saying—

Mr. GRAMLICH. He is another Governor.

Mr. SANDERS. He’s another Governor, OK.

Mr. Suays. That’s like saying, Mr. Sanders, that you work for
me, just because I’m chairman. [Laughter.]

I don’t think so.

Mr. SANDERS. And Mr. Greenspan has been going around the
country for years telling us how we have to cut back on the cost
of living for seniors for so forth and so on. Let me ask, Dr. Abra-
ham a question, if I might. Dr. Abraham, my understanding is that
a study conducted over several years by Nathan Amble, I may be
pronouncing it wrong, Nathan Amble, and Ken Stewart of the BLS
Division of Consumer Prices and Price Indexes found that since
senior citizens spend disproportionately on health care and other
goods with higher inflation rates, the CPI we use may actually be
too low for senior citizens, not too high. Could you comment on
that, on any other studies that you know that would indicate, in
fact, that the CPI might be too low for senior citizens?

Ms. ABRAHAM. The study that you’re referring to is a description
of the experimental CPI for the elderly that I already mentioned.
What the study concluded, what the calculation of this measure
shows, is that if over a period of years you take the data that we
collect for producing the regular CPI and reweight it in accord with
how elderly consumers spend their dollars, because of the higher
weight of medical care and prescription drugs the measure tended
to go up a bit faster, three or four tenths of a percentage point per
year faster than the overall CPI. But I have to say two things
about that. First, we didn’t, in putting this measure together, have
the resources to go out and figure out where these individuals were
actually shopping and what they were actually buying in the stores
that they frequented. We just reweighted the data that we already
had. So that may be an issue.

And, second, as Bob Gordon has already noted, the reason for the
difference in the overall index is because of the higher weight on
medical care and prescription drugs for those folks and there are
serious questions about our ability to appropriately adjust for
changes in the quality of medical care, and perhaps, prescription
drugs as well. So that how you view those results depends on what
you think about that matter.

Mr. SANDERS. I understand what you’re saying and I would be
the first to agree that the task that you are being given is a very
difficult one. I mean, it really is. My purchasing patterns are dif-
ferent than your’s and different than a 90-year-old person living in
a 20-below-zero climate, correct? But let me get back to the point
that you made. Would you agree with me that, in general, for sen-
ior citizens, they are more dependent on health care and prescrip-
tion drugs than the average person?

Ms. ABRAHAM. Yes, the data that we have shows they spend a
higher share of their consumer dollars on those things.

Mr. SANDERS. And would you agree, perhaps, unlike the gen-
tleman there who’s name, unfortunately his name, now it’s on
backward, let’s see if it works here, all right, Dr. Gordon, that the


8

third, we have made a commitment to update the market basket
more frequently in the future than the roughly every 10 years that
has been our practice in the past.

The second issue that I'd like to speak to briefly is the issue of
accounting for consumer substitution in response to relative price
change. We have, as you know, just earlier this month announced
changes in the way we calculate the subindexes that get aggre-
gated to produce the overall index. That’s adoption of the geometric
mean formula that you held up on a piece of paper, which is, in
our judgment, a way of dealing as best we can with consumer sub-
stitution that may occur among individual items within item cat-
egories. That change will take effect with the data for January
1999.

We also have requested funding to produce as a complement to
the Consumer Price Index, an alternative measure economists have
labeled a superlative index. That is a measure that accounts for
consumer substitution that takes place across item categories, rath-
er than within item categories. For reasons that I will be happy to
go into if you would like, that’s not a measure that we can produce
as a monthly index that doesn’t get revised, but it is something
that we can produce either with a bit of a lag, or as a measure
that’s an approximation and then gets revised. So we've made a
commitment to produce that alternative measure beginning in the
year 2002. The reason for that delay is that we will wait until we
have data from our expanded consumer expenditure survey which
we'll be fielding next year.

The third issue I’d like to speak to is the treatment of new prod-
uct introductions and change in the quality of goods and services.
We have a couple of things that we're working on there. First, we
have requested funding, again, as part of our Consumer Price
Index improvement initiative, to collect additional data on prices
and the characteristics of goods that would allow us to make more
explicit regression-based adjustments for change in quality. We’ve
done that kind of thing in the past in certain index components;
apparel is the biggest example. Effective with the data for January,
just several months ago, we introduced that better technique in the
personal computers and peripheral equipment component of the
index. Our future focus will be on looking at using regression-based
adjustments for appliances and consumer electronics, which were
index components highlighted in the Boskin Commission report.

Second, we have requested funding to ensure that in the future,
when new goods appear on the market, the example I’ve got in my
mind is electric cars, that we start collecting prices for those items
shortly after they appear on the market rather than with a delay.

And, third, we are making changes in the way that we update
our item samples to ensure that we focus on product and service
areas that are impacted by rapid changes in technology.

The agenda that I’ve just described represents everything that,
at the present time, we know how to do to improve the Consumer
Price Index. As has long been our practice, we will continue to look
for new ways to improve the index. We have an internal research
staff which I’m proud to be able to say has produced much of the
important work leading to past improvements in the CPI. But we


BUREAU OF LABOR STATISTICS OVERSIGHT:
FIXING THE CONSUMER PRICE INDEX—
PART II

WEDNESDAY, APRIL 29, 1998

HOUSE OF REPRESENTATIVES,
SUBCOMMITTEE ON HUMAN RESOURCES,
COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT,
Washington, DC.

The subcommittee met, pursuant to notice, at 11 a.m., in room
2247, Rayburn House Office Building, Hon. Christopher Shays
(chairman of the subcommittee) presiding.

Present: Representatives Shays, Towns, Sanders, and Kucinich.

Staff present: Lawrence J. Halloran, staff director and counsel;
J. Vincent Chase, chief investigator; Robert Newman, professional
staff member; Jesse S. Bushman, clerk; and Cherri Branson, mi-
nority counsel.

Mr. Suays. I would like to call this hearing to order, welcome our
witnesses, and welcome our guests. Welcome to the second in what
may become an annual oversight event for this subcommittee, a
hearing on the Consumer Price Index.

One year ago, less 1 day, we asked the Department of Labor’s
Bureau of Labor Statistics to describe their program to maintain
the objectivity and improve the accuracy of our most widely used
economic measure.

Today, we will assess their progress over the intervening 364
days, and we will discuss the Bureau’s vision, strategic plan, and
specific performance goals for constructing the most accurate cost
of living index possible in the years ahead.

Just 2 weeks ago, the BLS announced several methodological im-
provements and data enhancements to the CPI. These primarily
address the current failure to capture substitution by consumers of
cheaper or alternative items in response to price increases. Begin-
ning in January 1999, BLS will fix this flaw by using a geometric
mean formula, in place of a straight arithmetic approach, to com-
pute basic indexes for products now comprising more than 60 per-
cent of the total CPI market basket.

It is estimated that this step alone will eliminate two-tenths of
the estimated 1.1 percent upward structural bias in the index. In
all, BLS believes this and other steps taken since 1995 trim eight-
tenths of 1 percent from the CPI’s overstatement of inflation, but
what remains is of enormous significance.

The General Accounting Office has called for more frequent up-
dates of CPI expenditure weights, the relative emphasis placed on

@


42

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 9

studies of quality change for individual products and services take time, and the BLS cannot
possibly be expected to incorporate every new research finding in the monthly CPI,
especially since that, for good reasons, can never be revised. Establishment of the second
index will take a reorientation of research effort by the BLS. There will need to be a larger
research department and one that subcontracts to established organizations (Consumers
Union or the equivalent) to carry out long-term studies of changes in the quality of
consumer products and services. One frustrating aspect of Consumer Reports is that a huge
amount of information has been collected over the years that would allow a time-series data
base to be constructed on quality attributes, energy use, and repair incidence for a wide
variety of products. At the moment the time-series aspects of these data are not published
and are often difficult to extract from successive studies published in the magazine; this is
just the sort of research record that the BLS should be negotiating to preserve and to obtain.
Since the BLS cannot do everything all at once, the Commission members are sympathetic
with Nordhaus’ (1998) suggestion that we should advance beyond “the war of the anecdotes"
by randomly selecting a sample of consumer goods and services for intensive study (ie., not
just doing research on those that are easy to study but research a sample of everything, easy
and difficule alike). Quite a bit can be accomplished relatively rapidly with bar scanner data,
which allows a much faster introduction of new products and a much more adequate
treatment of substitution at the level of individual goods and services.

Upper-level substitution bias is another problem area. In January, 1998, the CPI

finally updated its upper-level weighting system from 1982-84 expenditure weights to 1993-


73

APPENDIX I APPENDIX |
CPLRELATED OBJECTIVES, PERFORMANCE GOALS,
AND FISCAL YEAR 1999 PERFORMANCE INDICATORS
: 7 ATORS
EFEICIENCY, AND RELEVANCY OF ECONOMIC MEASURES
Performance goal Fiscal year 1999 performance mdicator
Objective: Improve the quality of the Consumer Price Index (CPI)

Improve the CPI sample design and
estimation methodology used for CPI
rent and Owner's Equivalent (REQ)
estimates.

Use new sample design and estimation methodology for
rent and REQ in published CPI

Update the CPI market basket's Housing
sample to reflect current demographic
and geographic population
characteristics

Updated Housing sample used in published CPI

Update the CPI market basket’s
Commodities and Services sample to
reflect current geographic population
and expenditure pattems of all goods
and services

Published CPI includes

© certain previously unpriced services,

© prices collected for new goods and services
entering the market place,

© quality adjustment for certain goods and
services based on supplemental sample of prices
and characteristics, and

© —_new item samples based on Telephone Point of

Purchase Survey.

Develop alternative measures of change
an living costs.

Produce updated superlative indexes in an enhanced
research environment utilizing 1997 Consumer
Expenditure Survey data

Expand the Consumer Expenditure
Survey sample.

Begin data collection and processing of larger sample

Test an expernmental CPI using
geometric means.

Incorporate changes into the official CPI

Objective:
Producer Price Index, Inter

Improve service sector coverage in major BLS programs: Consumer Price Index,

mational Price Program, and Productivity.

Increase the coverage of service
industries’ price and productivity
indexes.

Published CPI includes certain previously unpriced
services.

Source: BLS' strategic plan and fiscal year 1999 performance plan.

22


82

index on the average family budget, in other words, the average
family?

Ms. ABRAHAM. The Bureau of Labor Statistics back nearly 20
years ago now, did have a program called the Family Budget Pro-
gram that was designed to go out and collect information on actual
expenditures by high-income intermediate income, and low-income
families. So, in principle, were that”something that the Congress
were to decide it wished to fund us to do, would be something that
we could do.

Mr. Towns. OK, fine. But in other words, you stopped it because
the Congress would not fund you to do it?

Ms. ABRAHAM. There were—

Mr. Towns. Now, let me say, I’m very concerned about this
whole thing, and I’m very nervous. You might even detect it in my
questions, that as to where we’re going here, and I think that’s
very important to the average family. So did you stop it because
of the lack of funds or other reasons?

Ms. ABRAHAM. I should say that this program was discontinued
a good long while before I came to the BLS, but my understanding
is that it was discontinued because, first, the Bureau experienced
large reductions in its budget in the early 1980’s and second, be-
cause when it came to making choices about which programs would
be kept and which programs were to be let go, there were some
questions about the conceptual underpinnings of that program.

Mr. Towns. Let me ask the other members of the panel. Do you
see a need for this?

Mr. Gorpon. I would rather have the hypothetical funds for such
a program go into a larger sample for the CES which in turn allow
more frequent updating because their reason for using these 3 av-
erage years of data is the small sample size, so.

Mr. Suays. For the record, when you say, CES, it is the con-
sumer expenditure-——

Mr. Gorvon. Expenditure survey.

Mr. Towns. So, I’m sort of detecting that maybe we're not spend-
ing enough to get what we're looking for here, you know.

ir. GORDON. I think that’s a reasonable conclusion.

Mr. Towns. I mean, I don’t want to roll the dice. I don’t shoot
the crap here.

Mr. GorDON. One thing you should be asking today, I think, is
whether the BLS’ own plans and requests are ambitious enough be-
cause the implication of what I was saying is that there are still
recommendations that, to be fair, they can’t do everything all at
once but they could have a 5- or 10-year plan with a ramping up
of expenditure that would sort of set out before Congress in ad-
vance so that 5 years from now you could have some of these rec-
ommendations already implemented.

Mr. GRAMLICH. If I could enter in on this? This matter has been
studied a little bit to the extent that the data are available and,
frankly, you don’t see enormous differences between the inflation
of high and low income families. It may be that as a regular matter
whoever made this decision back 20 years ago to discontinue the
three or four indices was, that may have been a sensible decision.
At the same time, that matter could be studied every now and
then. I don’t think you’d have to do it more than every 10 years,


BUREAU OF LABOR STATISTICS OVERSIGHT:
FIXING THE CONSUMER PRICE INDEX—PART II

HEARING

BEFORE THE

SUBCOMMITTEE ON HUMAN RESOURCES

OF THE

COMMITTEE ON GOVERNMENT
REFORM AND OVERSIGHT
HOUSE OF REPRESENTATIVES

ONE HUNDRED FIFTH CONGRESS
SECOND SESSION

APRIL 29, 1998

Serial No. 105-135

Printed for the use of the Committee on Government Reform and Oversight

ae

U.S. GOVERNMENT PRINTING OFFICE
49-557 WASHINGTON : 1998

For sale by the U.S. Government Printing Office
‘Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-057264-9



108

Statement before the House Subcommittee on Human Resources,
Committee on Government Reform and Oversight

Hearing on:
“The Bureau of Labor Statistics: Fixing the Consumer Price Index”
April 29, 1998

Jack E. Triplett!
Brookings Institution

J 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 January, 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.”

' The views expressed are solely my own and not necessarily those of the trustees, officers and
staff of the Brookings Institution.


131

is drawn for such family ot families. The Boskin panel did not address this issue, but should have.
‘The BLS, itself, has reported some experimental results, evaluating different approaches to the

issue, but it too has not reported plans to consider it.

‘The present CPI covers all-urban consumers. Its weights are calculated by adding spending
of urban consumers in each expenditure category and calculating expenditure proportions at the
economy level — 15 percent on food, 5 percent on apparel, etc. The item sample is then drawn

to represent consumer spending in those expenditure categories.

‘There is an alternative method discussed in the economics literature that can be applied to
the CPI-U, or a more narrowly-defined index family. It is to use an average of the percentage
distribution of individual household expenditures among market basket categories. The present BLS
weighting system gives more weight to spending patterns of upper income families because per
household they spend more dollars. In view of the increase in the inequality of the distribution of
income, the CPI weights have become even less representative of the typical American household.
Angus Deaton, in a contribution to the aforementioned Symposia in the JEL, has calculated that
in 1990 the U.S. household for which CPI weights are correct lies at the 75th percentile of the
expenditure distribution. It would be even higher than that if more recent data were used and
income were used instead of expenditures. The BLS method serves to place a higher weight on the

more expensive varieties of goods like personal car phones, home computers, and airline travel.




109

‘The Boskin Commission defined “upper level substitution bias” as the difference between the
Laspeyres formula and a formula that estimates a cost-of-living index. It estimated upper level
substitution bias at 0.15 percentage points, annually. 1 concur with this estimate, which is based
entirely on empirical work conducted by BLS staff (when I was at BLS from 1971 to 1985, I
directed the early BLS research on substitution bias).

‘As the Boskin Commission noted, upper level substitution bias could be eliminated by using a
“superlative” index number formula for the CPI. The Fisher index now used by the Bureau of
Economic Analysis to measure Personal Consumption Expenditures (and consumption prices) in
the national accounts is an example of a superlative index.

Even with the CPI's traditional Laspeyres formula, substitution bias would be minimized if
weights were updated frequently, and were kept current. Though the Laspeyres formula will
always be subject to some substitution bias, when the weight year is very close to the current
year, the bias will normally be small.

The new, updated CPI weights are a positive step that improves the CPS. However, the weights
are already roughly four years out of date (the mid-point of the new weighting period is 1994).
Even if the CPI weighting cycle is cut in half in the future, so weights are replaced every five
years, by 2003 the weights will be approximately nine years old. In today's heightened concem
for CPI accuracy, nine year old weights may be unacceptable. Few other countries tolerate CPI
weights that grow so old before replacement. For example, in the new “harmonized” CPI for
Europe, the maximum age for any country’s weights is seven years, and the average weight age
across European countries will be less.

As an additional consideration, upper level substitution bias may not always remain small. If
shocks such as the oil and energy shocks of the 1970's occur, resulting in substantial changes in
consumption patterns, substitution bias might be larger in the future than in the past. If it takes
several years to get new weights into the CPI, an unanticipated shock might distort the CPI for an
unacceptably long period. A regular program for introducing up-dated CPI weights that are as

Further reduction of weighting effects in the CPI could be accomplished by improving the
Consumer Expenditure Survey so that the CPI would have: (1) annual weights (a single year, not
three years’ average, as now, or two years’ average, as BLS has proposed), (2) weights that are
introduced not only more frequently but also more expeditiously (so they would be more up to
date), and (3) weights that are more accurate than those in the present index. What matters is not
just the frequency of re-weighting. The currency and the accuracy of the weights matter as well.
Improving the currency and accuracy of CPI weights requires improving the Consumer
Expenditure Survey.


30

Returning to my primary message, a study of substitution bias and an outside review
panel holds the promise of forming the basis of a reasonable professional consensus on limited
technical changes that would correct substitution bias and make the CPI a more accurate measure
of the cost of living. Such a consensus is critical for maintaining public support and confidence
in our statistical programs. That confidence can only be enhanced when the government is

striving to develop the most accurate measures possible.


89

Ms. ABRAHAM. My concern here is what technically it would be
feasible for us to do if requested. And I think there would be a lot
of difficult issues associated with trying to figure out how to do this
right.

Mr. SANDERS. Whoa, whoa, whoa, 1 second. Everything that
we're talking about is difficult.

Ms. ABRAHAM. Right.

Mr. SANDERS. But you will agree with me, and I trust everybody
will agree with me, that we want the best statistics that we can
get. What we all know, and common sense dictates, and you tell
me if you disagree with me, that a young person in a warm cli-
mate, or forget the warm climate, a 20-year-old has different pur-
chasing needs than an 80-year-old person, right?

Ms. ABRAHAM. The purchasing patterns clearly are different.

Mr. SANDERS. So it would seem to me elementary that we would
want to, if 40 million people are receiving Social Security, and by
the way it’s half of the folks have incomes, I believe, under $15,000
a year, so this is important whether they get that extra $200 or
not, OK? I don’t, and to say that it would be difficult, I’m sure that
it would be difficult but that’s what you and your agency are paid
to do. Why—you could do it, I mean, you’re not suggesting to us
that you can’t?

Ms. ABRAHAM. I can tell you what specific thing I think would
be difficult and I don’t know quite how we'd deal with it. The way
that we put the index together now when we go into stores, we're
trying to pick items that are representative of what people buy in
those stores and I don’t know how we’d figure out if we went into
a store which items the older people are buying as compared to
what the average——

Mr. SANDERS. Why can’t you figure that out? I mean, that’s what.
you would be asked, senior citizens have, so you have to study that.
That’s what we would be asking you to do. Senior citizens do not
usually buy $5,000 computers, right? At least in my State they
don’t. Senior citizens would not buy too many, you know, rock and
roll records and so forth. They don’t have records any more, discs,
you know, and so forth. But senior citizens do buy prescription
drugs and they do have to heat their homes warmer than other
people. You could do that. I mean, it’s not, sure, it would be a chal-
lenge. But if you can’t do that then what the heck do we have the
Bureau of Labor Statistics for? That’s what your job is, isn’t it?

Ms. ABRAHAM. Well, we could certainly work on it. I do want to
say again, that I think there is a distinction between what from a
policy perspective is the right thing to be doing and what kind of
information we’re——

Mr. SANDERS. But I’m not talking about policy. I’m talking about
getting the chairman, I think misunderstood me before in the sense
that I am not saying raise the CPI because you have a lot of low-
income senior citizens. That is not what I’m saying. That is a policy
decision that we should debate. I agree with you, what you want
these folks to do is give us the facts right? And I agree and then
we will go with the facts. But I’m suggesting to you, and I don’t
think you’re strenuously disagreeing that the facts for senior citi-
zens may be different than they are for other people in the popu-
lation?


84

Ms. ABRAHAM. That would really be a policy evaluation exercise
that we wouldn’t be the agency working on, I think. Evaluating
whether an anti-poverty policy is working is not something that we
would look at. Others might use our data to look at that but per-
haps others could comment on this?

Mr. Towns. You know, go ahead, Dr. Gramlich, because I want
to come back to you.

Mr. GRAMLICH. Well, I think that Katharine just answered the
question. Frankly, I wasn’t, aware that the BLS had an experi-
mental index on low-income consumers but that certainly gets
close. You could certainly do that on a more extensive basis.
know, you could have poverty level consumers——

Mr. Towns. Yes.

Mr. GRAMLICH [continuing]. Which would be a little different
from low-income consumers. But I repeat that to the extent people
have done this kind of work they haven’t observed large differences
in the rate of inflation.

Mr. Towns. Could you tell me about some other studies where
it’s actually happened?

Mr. GRAMLICH. I can’t sitting right here.

Mr. Towns. Right.

Mr. GRAMLICH. We'll, we could—

Mr. Towns. I’m not trying to, I’m really trying to educate myself.

Mr. GRAMLICH. We can supply you with what we have and I hope
BLS will as well.

Mr. Towns. It’s not a test. I’m not giving you a test. [Laughter.]

Really, I’m trying to get some information for myself because this
is. Who knows we might have to make a decision here. I need to
have as much information as I possibly can to—yes? You want to
comment on that too?

Mr. GorDON. I was only going to mention that the studies of the
cost of living of the elderly have generally concluded that the only
real factor that causes inflation that’s different for the elderly is
prescription drugs and medical care. Those conclusions are, there-
fore, sensitive to the research of a number of people in the last 5
years that have identified substantial overstatement of the cost of
prescription drugs in the CPI by getting the actual original data
from drug companies.

Mr. SANDERS. Can I just jump in?

Mr. GORDON. Sure. .

Mr. SANDERS. Without arguing, without arguing your point what
about the fact that senior citizens are much more dependent upon
prescription drugs than younger people? Isn’t that really the issue?
That seniors spend a far higher percentage of their income on pre-
scription drugs than the average person?

Mr. GorDON. That only matters if the rate of inflation for pre-
scription drugs is dramatically different than the rate of inflation
for everything else.

Mr. SANDERS. You're going to deny that? You’re really, are you
going to tell us now that prescription drug rates are not going up
substantially higher than general inflation? Are you going to be the
only person in America to make that claim? I’d love to hear it, I
mean, that’s so clearly untrue. But I’d like, if that’s what you
think.


12

weight updates in a more timely fashion. Further, it has
become apparent that shortening the roughly 10-year
interval between comprehensive updates to the CPI would be
desirable, and we have work underway to determine a more
appropriate time schedule for such updates. I should note,
however, that the availability of new Census of Population
information likely always will necessitate some form of
periodic CPI updating to account for shifts in the
distribution of the population. Thus, I suspect that
updating of the CPI geographic sample may well, of

necessity, remain a decennial statistical activity.

Finally, both for the sake of completeness and because it
is important in its own right, I should call the
Subcommittee’s attention to an improvement in the treatment
of quality changes in personal computers also introduced
with data for January 1998. The revised item
classification structure for the CPI that I already have
mentioned includes a new stratum called Personal Computers
and Peripheral Equipment. Analysts in the BLS Producer
Price Index (PPI) program earlier developed and implemented
a regression procedure, called a hedonic model, that
attaches an implicit price to each important feature and

component of the computer. Starting with the CPI for


54

Congress has been concerned with whether the CPI accurately reflects consumer
spending, and the Senate several years ago chartered the Advisory Commission to Study
the Consumer Price Index (also referred to as the Boskin commission). The commission
concluded in its December 1996 report that the fixed market basket CPI (1) becomes less
and less representative of consumer spending over time as consumers respond to price
changes and new consumer choices and (2) overstates the true cost of living.' The
commission estimated the size of the overstatement for the next few years to be 1.1
percentage points per year, and it made recommendations to BLS and to the President
and Congress. Within the community of professional economists and statisticians, the

commission's report is supported by some and opposed by others.

‘As requested, I will discuss three topics today: (1) the need for and advantages of more
frequent updating of the CPI expenditure weights, (2) the nature of the work we are
currently doing with regard to the CPI, and (3) BLS' coverage of CPI improvement efforts

in its strategic plan and fiscal year 1999 annual performance plan.

‘The Boskin commission's December 1996 report to the Senate Committee on Finance
was titled Toward a More Accurate Measure of the Cost of Living.

3


96

Mr. Towns. So—.

Mr. GorDON. Same with the cell phone.

Mr. Towns. So what should we do then? Let me, maybe I can,
what should we do then in order to get accuracy here? Maybe I’m
asking the question wrong.

Mr. GorDON. Well, let me just turn this to Katharine and ask
what specific things the BLS is doing to ensure an earlier introduc-
tion of new products?

Mr. Towns. Before that, and also, I’m going to recognize you, I
saw your hand. I recognize you, yes, go ahead Dr. Abraham.

Ms. ABRAHAM. We're doing a couple of things. We have intro-
duced plans to ensure, in a targeted way, that if a new item ap-
pears on the market that we start collecting the price promptly
rather than what has sometimes occurred, after a substantial lag,
so that we would capture that initial decline in price.

And, second, this more generally, we’re taking steps to ensure
that in market segments where there’s a lot of change going on
that we’re updating the samples of specific items that we're pricing
more frequently than the roughly every 5 years that updating of
specific price items currently occurs. So we're taking steps to try
to get things in more promptly, response if that’s responsive to
your question.

Mr. Towns. Yes.

Ms. ABRAHAM. And we agree that it’s something that it’s impor-
tant to be doing.

Mr. Towns. Yes, I think you had your hand? Thank you.

Ms. SCHOLL. I just want to make the point that when these par-
ticular products were introduced. These were introduced at the
time of major revisions and that was the point that we’re making
in our report—the weights of the market basket items should be
updated more frequently. That would allow the introduction of
some of these things that have in the past not been included for
10 years or so. It’s because the weights were not updated for such
a long period of time. When the item was introduced in between
these revisions, it was not included in the market basket.

Mr. Towns. Thank you very much. But let me just say that, in
closing, I come from Brooklyn, where there are 2.5 million people.
And I’m just trying to think of—I think I can come up with like
one major discount store. I’m trying to think and I’ve been sitting
here, and I’m back there every week. I can only think of just one
and there’s 2.5 million folks that live in Brooklyn, you know——

Mr. SHays. Can I make an assumption that people in Brooklyn
go into other parts of New York City? [Laughter.]

I mean, with all due respect——

Mr. Towns. Well, no, but you have to understand that generally,
if you have to—that’s another factor, you just raised that issue. If
you have to go away somewhere else to do it, then is that cost in-
cluded? I mean, I don’t know. I mean, you just raised another
issue. And then can senior citizens do that? I mean, these are
issues that I need to have more on. I mean, and I understand that
Dr. Abraham cannot do everything but I just think some of these
things are just so important that they must be done. I mean, that’s
my view of my feelings.


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36

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 3

addressed, they worked together with us to identify the nature of the problems and potential
solutions, and they generally welcome the attention that our Commission and final report
has directed to the need for more investment in the quality of government statistics, both
in the CPI and more broadly. Some of the initial BLS reactions to our report were
contained in a paper by the former head of research at the BLS, who was generous to our
report and called it "the most influential critique of the CPI in decades.” Subsequent to the
release of our report, the BLS has moved swiftly to implement one of our major
recommendations.

The portion of our report and recommendations concerning upper-level and lower-
level substitution bias received widespread support and little if any criticism. In fact, the
leading academics outside the government who have studied this issue (Shapiro and Wilcox,
1997) have suggested that we may have understated the upper-level substitution bias by 0.1
percent, The recommendation that the BLS has swiftly adopted is in this category, lower-
level substitution bias, and this occurred on April 16, 1998, when the BLS announced that
roughly 60 percent of the CPI would shift to geometric means for lower-level aggregation,
and I believe that our Commission members are supportive to the factors that the BLS cited
in excluding roughly 40 percent of consumer expenditure from such treatment in such areas
as purchased shelter, utilities, and selected medical care services.

The criticisms of our report centered on our treatment of quality change and new
products. While at least one prominent academic feels that our report understated the value

of new products, most of the criticisms implied that we had overstated the extent of bias,


exes and Quality Change: Studies in New Methods of
Measunment. Cambridge: Harvard University
Press, 1971

Griliches, Zvi, and Iain Cockburn, “Genetics
and New Goods in Pharmaceutical Price In-
dexes.” American Economic Review, December
1994, 845, 1213-1

Hausmaz, Jerry. “Valuation of New Goods Une
der Perfect and Imperfect Competition.” In
Bresnahan, T, and Robert J. Gordon. eds. The
Economics of New Goods. Chicago: University of
Chicago Press. 1996.

Hausman, Jerry, “Cellular Telephones, New
Products and the CPI,” NBER Working Paper
No. 5982. 1997,

Hausman, Jerry, “Comment on CPI Conuiy
sion Report.” 1997 Papers and Proceedings,
Amuvican Ecanomic Keairw, Mav 1997, 872, 96-97.

Hicks, John R., “The Vahiation of the Social
Income,” Economica, May 18140, 7:26, 105-24

Jorgenson, Dale W., and Daniel T. Slesnick,
“Individual and Social CostufLiving Indexes.”
In WE, Diewert and C. Montmarquette, eds. Pace
Level Measurement, Ottawa: Statistics Canada.
1988, 241-336.

Moulton, Brent R., “Bias in the Consumer
Price Index: What is the Evidence?” Journal
of Economie Perspectives, Fall 1996. 10-4,
189-77.

Moulton, Brent R., and Karin E. Moses, “Ad-
dressing the Quality Change Issue in the Con-
sumer Price Index,” forthcoming in Brookings Pa
uns on Economie Activity, 1897.

Nordhaus. William D., “Do Real-Ourput anc
RealWage Measures Capture Reality? The His:
tory of Light Suggests Not.” In T. Bresnahan and
RJ. Gordon. eds. The Economics af New Goods. Uni-
versity of Chicago Press. 1996.

Nordhaus, William D., “Bevond the CPI: An
Auginented Gost of Living Index,” presented at
NBER Productivity Workshop, 1996.

Nordhaus, William D., “Quality Changes in
Price Indexes.” Journal of Feonomic Perspectives,
this issue.

Pollak, Robert A., “The Social Cost of Living
Index.” Journal of Public Economics, June 1981,
158, 311=36.

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Pollak, Robert A., “The Consumer Price In-
dex: A Research Agenda and Three Proposals.”
Journal of Economic Perspectives, this issue.

Reinsdorf, Marshall, “The Effect of Outlet
Price Differentials on the U.S. Consumer Price
Index.” In M. Foss, M. Manser, and A. Young,
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ies in Income and Wealth, Vol. 57. Chicago: Uni-
versity of Chicago Press, 1993.

Rubin, Rose, and Kenneth Koelin, “Elderly
and Nonelderly Expendiatres on Necessities in
the 1980's,” Monthly Labor Review, September
1986, 77 2-31

Shapiro, Matthew D., and David W. Wilcox, “Al-
ternative Strategies for Aggregating Prices in the
CPI,” NBER working paper 5980, March 1997.

Shapiro, Matthew D., and David W. Wilcox,
*Mismeastirement in the Consumer Price Index:
‘An Evaluation.” NBER Macroeconomics Annual
199%,

Stifman, L., and C. Corrado, “Decomposition
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Studies. Federal Reserve Board, November 18.
1996,

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7

Mr. Chairman, Members of the Subcommittee, thank you for inviting me to testify on
improving the Consumer Price Index. Please accept my written testimony and enter it into the
record. It should also be noted that the following testimony is my own view and does not
necessarily reflect that of The Heritage Foundation.

The Consumer Price Index (CPI), along with the unemployment rate, is one of the two most
important economic statistics produced by the Bureau of Labor Statistics (BLS). The CPI is a
weighted measure of the average change in the prices of a fixed market basket of goods and
services. It is important because it not only is a central target of monetary policy, but also because
it significantly affects government data and therefore the public policy debates surrounding such
things as real wage and income growth.’ For example, the implication of overstating inflation by
1.1 percentage points per year from 1973 to 1995 means that real hourly wages have actually
increased 13 percent instead of falling by 13 percent as currently reported?

‘The CPI is also important because it has major federal budget implications. In the current
fiscal year, roughly 30 percent of total federal outlays ae indexed to movements in consumer
prices. Social Security, SSI, veterans’ pensions, mi
for the bulk of this spending. Tax receipts are affected because individual income tax brackets,
personal exemptions, and standard deduction are adjusted -- that is indexed — according to the CPI.‘
Individual income taxes account for about 45 percent of federal receipts.

There is widespread consensus that the CPI significantly overstates the rate of increase in
the cost-of-living. This problem received even more attention with the release of the 1996 Boskin
Commission Report.’ The weight of evidence from the academic community, the Federal Reserve,
the Congressional Budget Office (CBO), and even the BLS is overwhelming * This upward bias in
the CPI has and will continue to have significant implications for public policy decisions. Even
after the next set of revisions to the CPI is completed in 1999, significant upward bias will remain.

‘There are a variety of methodological problems that, when combined, result in a
significant overestimate of the increase in the cost-of-living.” To their credit, the BLS has a

' Despite the best efforts of the BLS, many people mistakenly refer to the CPI as a "cost-of-living" index. As
BLS-published descriptions make clear, the CPI as currently constructed will tend to rise more rapidly than a rue
cost-of-living measure.

2 The CPI also effects among other things the real rate of economic growth, productivity, and the poverty rate.

? Michael J, Boskin, “Prisoners of Faulty Statistics,” Wall Street Journal, December 5, 1996, A20.

“The CPI also affects around 28 other intemal Revenue Code sections. See Bureau of National Affairs, Daily
Labor Report, December 5, 1996.

+ Final Report of the Advisory Commission to Study the Consumer Price Index, Toward a More Accurate Measure
of the Cost of Living, Committee on Finance, U.S. Senate, 104" Cong., 2% Sess., December 5, 1996. Also known as
the Boskin Commission after its Chairman Michael J. Boskin.

* Michaet J. Boskin, Ellen R. Dulberger, Robert J. Gordon, Zvi Griliches, and Dale W: Jorgenson, "Consumer
Prices, the Consumer Price Index and the Cost of Living,” The Journal of Economic Perspectives, Vol. 12, No. 1,
Winter 1998.

The Four major problems are: 1) lower-level and upper-level product substitution bias (when the price of beef goes
‘up people buy more chicken): 2) an outlet substitution bias (as prices rise consumers may switch to new discount
stores not sampled by the BLS), 3) a new product bias (new products are not introduced into the CPI, or included



53

Mr. Chairman and Members of the Subcommittee:

lam pleased to be here today to assist the Subcommittee in its deliberations with the
Bureau of Labor Statistics (BLS) on the Consumer Price Index (CPI), one of the most
important indexes produced by the federal government, The Subcommittee has asked us
to address several topics related to making the CPI more reflective of current consumer

spending.

According to BLS, the CPI is the principal source of information on trends in consumer
prices and inflation in the United States and affects nearly all Americans because of the
many ways it is used. For example, it is often used to increase wages and benefit
payments to adjust for the erosion of consumer purchasing power due to inflation. In
1997, the federal government adjusted the benefits of 43.6 million Social Security
beneficiaries and 21.4 million food stamp recipients because of the growth in consumer
prices as reported by the CPI. In addition, federal tax brackets are adjusted automatically

by the CPI to prevent inflation-induced increases in tax rates.

To gauge the level of inflation in consumer prices, the CPI tracks prices for a fixed
"market basket" of goods and services that urban consumers purchase. These purchases
are for food, clothing, shelter, fuels, transportation, medical care, entertainment, and
other goods and services that people buy for day-to-day living. Only those expenditures

made by consumers (not including businesses) are captured in the CPI.


138

it should be two or three, when it starts going up to four and five,
we'll know there’s been an acceleration of inflation.

Mr. Towns. Right. Thank you very much. Let me just sort of
close on this, you asked, you answered in terms of the pilot project,
part of this early on but should I be concerned about the effects
that reduction in the CPI would have on Social Security and Medi-
care? The elderly are least likely to be able to absorb a reduction
in income. If this is a problem, what should be done about it? Well,
first of all, is it a problem, would you see it as a problem?

Mr. Popkin. Well, in many respects that’s, that’s a policy issue.
The part of the policy that I would react to is the following: that
as I understand the tax law, there, if you, if you’re on Social Secu-
rity but your income exceeds $26,000 then part of your Social Secu-
rity is taxed. So let’s say that you cut the CPI and that cuts a $100
a year off everybody’s Social Security payment. For the person in
the higher income bracket, it means he doesn’t have to pay quite
as much as taxes. So that really says that a $100 reduction in So-
cial Security payments for someone whose Social Security is not
taxed is a full $100. If you’re taxed on your Social Security, it’s less
than $100. So there’s that sort of regressive aspect to it.

Mr. Towns. Any other comments? I think you——

Mr. TRIPLETT. Yes, I think I would agree with something that
Bob Gordon said this morning. There are a lot of considerations in
escalated Social Security payments that ought to be taken into ac-
count that probably aren’t CPI issues. And what we're really inter-
ested in, I think, in the broad sense is fairness and equity and how
we're going to distribute the total resources we've got among the
retired and the un-retired people. And I’m not sure that we've
thought enough about how we should do that distribution and how
we should do the escalation, in focusing exclusively, we focus on
the CPI because that’s——

Mr. Towns. Right.

Mr. TRIPLETT [continuing]. The way it’s done now but that’s not
the only way to do it. And maybe looking at this issue in a broader
context is more fruitful than focusing too much on the CPI issues
in relation to Social Security.

Mr. Towns. Good, excellent point.

Mr. TRIPLETT. Yes.

Mr. WILSON. I agree Dr. Triplett and Joel that accuracy here is
really the primary issue when you're discussing CPI. In terms of
the equity issues and the impact on how it’s felt is a different pol-
icy discussion. There’s been a lot of discussion about indexing,
changing the index to a wage based, a wage inflator rather than
a price inflator, price index, so, that’s a different discussion. I think
what’s really most important in what’s in front of us today is get-
ting the best and most accurate cost of living measure that we can
get.

Mr. Towns. Thank you very, very much. You’ve been extremely
helpful. Mr. Chairman, I yield back.

Mr. SHays, I thank you Mr. Towns, also this panel, I thank you
for your patience in waiting for us to get through the first panel


49

Mr. SHays. Thank you, Dr. Gordon.

Mr. Ungar.

Mr. UnGaR. Mr. Chairman, members of the subcommittee, we’re
pleased to be here today to discuss our work that we have done
over the last couple of years on the Consumer Price Index. I'd like
to provide a short summary statement, and I, and my colleagues
would then be available, along with the other panel members, to
respond to questions.

I would like to talk briefly about two issues that we have looked
at. The first has been mentioned and it deals with the need for,
and advantages of, updating the current market basket weights
more frequently than every 10 years or so, which has been BLS’
practice recently, or at least since 1940.

In October 1997, we issued a report on that topic. All the evi-
dence that we gathered during the course of our work for that re-
port pointed to the need to have more frequent updates, to have
the CPI be more accurate, regardless of which direction it would
go in.

The evidence that we gathered did include the use of a number
of knowledgeable professionals, including a previous commissioner
of BLS, and other researchers, including several members of the
Boskin Commission. Practices of a number of other countries were
also looked at to see how they compared with the practices with
our country.

Although there are some differences in the types of indexes, and
how they go about calculating their indexes, we still noted that
they had more frequent update practices. We also looked at the re-
sults of a great deal of BLS research that had been done over many
decades that relate to the differences in indexes, before and after
introduction of new indexes, and using different alternative means
of computing indexes.

And, finally, we looked at the cost of updates, or the estimated
cost of updates, versus the potential benefits. And all that informa-
tion collectively led us to believe that it would be quite helpful to
have a more frequent update. We recommended that to BLS in our
report, and as the commissioner indicated, BLS did agree with our
recommendation. However, she appropriately noted that the evi-
dence that exists to date doesn’t really point to a particular time
period or time interval, or when the most appropriate time to up-
date would be. BLS is currently considering that as far as we un-
derstand. So we're certainly looking forward to the decision that
BLS comes up with in terms of the frequency of updates, assuming
the current fixed market basket is continued to be published and
used.

The second issue that we looked at is a little different from what
the other panel members have discussed. At the subcommittee’s re-
quest, we looked at the extent to which BLS has addressed efforts
to improve the quality of the CPI in its plans that had been pre-
pared under the Government Performance and Results Act of 1993,
otherwise known as “the Results Act.”

There are two topics I’d briefly like to talk about here. One has
to do with the extent to which its 1999 performance plan, which
it recently released, addressed the area of improving the CPI’s
quality. I might point out, however, the BLS is not required by the


78

Mr. Says. Thank you very much. You know, I was thinking, as
we've gone through, what I'd like to do before any of us start our
questions is, Dr. Abraham, if you want to just comment on what
you've heard, I’d be happy to give you that opportunity. I noticed
you were taking notes and if there’s anything you want to make
a comment on and then we'll start our questioning. You don’t have
to but if there’s anything?

Ms. ABRAHAM. I, perhaps, might thank all three of the other wit-
nesses for the kind things they had to say about the work of the
BLS, which I greatly appreciated. Why don’t I, perhaps, leave it at
that. There were some things that were brought up concerning
areas in the——

Mr. Suays. I just wanted to give you the chance if you want-
ed—.

Ms. ABRAHAM [continuing]. Boskin report that we hadn’t yet pub-
licly made commitments on and comments about our strategic plan,
but rather than my commenting, perhaps I could—

Mr. SHays. OK, why don’t we just start with the questioning,
and I will start out, so we'll start the clock. We’re going to do it
one, 5 minutes, and if you’d just check your watch to make sure
this thing is accurate because it seems to be, and then tip it over
one time and we'll do 10 minutes and then go through.

First off, what I learned from the last hearing is as much as I
may have some questions about the accuracy of the CPI, I felt fair-
ly convinced after the hearing, not just from listening to BLS but
from others, that a legislative solution would not be productive. In
other words, just arbitrarily deciding what we want it to be would
not be productive. And what I was also left with was, one, that
BLS has some work cut out for itself, and also that we need to
make sure that we are providing the resources to have that done.

So the first question I want to ask is, are you asking for the re-
sources you need, and is the administration supporting you in that
effort, and is Congress supporting you? And so I'll start with you
Dr. Abraham.

Ms. ABRAHAM. Taking those three in turn, as part of the CPI im-
provement initiative, which we first proposed last year and have
asked for a second installment of funding for fiscal year 1999, we
have asked for resources to support, as I think I may have indi-
cated in my opening statement, everything that we know how to
do at this time to improve the CPI. The administration has been
very supportive of our resource requests. The Congress supported
us last year and I hope will support us this year.

Mr. Suays. Just so it doesn’t get lost, I want to make sure that
you contact this committee if you don’t feel that that is happening
in terms of Congress’ response. The request has been made and
you're satisfied with the request the administration has made for
your budget?

Ms. ABRAHAM. Yes.

Mr. Suays. And I just need to make sure you stay in touch with
the committee. I just wanted to make sure that’s part of the record.
I make an assumption that when the effect of the CPI is on both
spending and the lasting image from my budget committee days
has been that it affects 60 percent of spending and 40 percent reve-
nue. Is that something you would be able to respond to, or should


88

statistics are pretty clear that prescription drug costs are going up
a lot faster than general inflation?

Ms. ABRAHAM. If you look at our measures over the past 10 years
or so, on average medical care as a whole, and I’m afraid I don’t
know off the top of my head about prescription drugs specifically,
has gone up at a faster rate than overall inflation as captured by
our measures. And the question is whether you agree that the way
we're constructing those measures is appropriate and I have to ac-
knowledge that appropriately adjusting for changes in quality in
that area is particularly difficult.

Mr. SANDERS. It’s a difficult issue. I kind of think that in the real
world, I mean this is honestly, people, the senior citizens of Ver-
mont, you talk about MediGap going up 30 percent this year in my
own State. Prescription drugs going up higher. People do not have
the slightest doubt that their health care costs are going up a lot
faster than inflation.

My question, and I think you touched on this, we understand
that the CPI affects a whole cross-section of our population, and I
think we can agree from a commonsense point of view we don’t
want 50 different categories, right? If you're 23 years old and living
in Los Angeles and 80 years old living in Vermont, you know, it
would drive us all crazy. But on the other hand, why aren't we not
looking more seriously at a CPI for seniors who are on social secu-
rity and take a look at their costs as opposed to a lot of younger
people whose inflationary needs may be lower than seniors?

Ms. ABRAHAM. This question has come up in the Congress a
number of times. Back in the late 1980’s there was congressional
interest in the possibility of the Bureau of Labor Statistics produc-
ing an official CPI for the elderly and there was an exercise carried
out to look at the issues we confront and try to come up with some
estimates of the cost of doing that, and in the end there was no
decision by Congress to provide the resources to pursue that.

Mr. SANDERS. How much would something like that cost, you
guess, I know it’s——

Ms. ABRAHAM. I would guess that it would cost at least as much
as producing the CPI itself. It would be that kind of ballpark figure
because you'd have to go out and collect for the elderly information
on prices in the stores where they shop of the items they purchase.
So you'd really be talking about duplicating what we do now for the
overall population. There would be a little overlap in the sample
because we do have elderly folks included but the extra cost would
be substantial.

Mr. SANDERS. No, I recognize, as we've all heard, Mr. Chairman,
as you have said, the CPI affects a lot more than senior citizens
but we have how many Social Security recipients in this country,
does anybody know offhand?

Ms. ABRAHAM. Forty million.

Mr. SANDERS. Forty million folks. I kind of think when 45 million
people are going to be effected by the decisions that you are con-
templating right now, I think that the amount of money that it
would take to come up with a good and fair study is well worth it,
is well worth it. Is that something that you would like the Con-
gress to do?


43

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 10

95 weights. However there has been no commitment to the Commission’s major
recommendation that the Laspeyres formula be abandoned, and that the infrequent ten-year
revision cycle be abandoned and replaced by a "permanent" revision cycle, with the upper-
level weights revised every year to respond, with only a one-year or two-year lag, to the
shifting pattern of consumer expenditures.

The problem of outlet substitution bias has been subject to virtually no research,
academic or otherwise. We know that by one index the share of discount department stores
has increased from 45 percent to 65 percent of the total over the past decade, but no
systematic series exists to produce a measure of the average discount in one type of store as
contrasted with another. While the BLS has maintained its position that price differentials
for a given good reflect differences between full-service and minimal-service outlets, we
maintain the position that many discount retail chains enjoying an increase in market share
~ Wal-mart, Target, Home Depot — provide the same service or better service than the K-
Marts and bankrupt Woolworths and Montgomery Wards which are losing market share.
The BLS needs to carry out itself, or fund in the academic community, a major research
effort to collect data on retail price differentials to complement existing data on sales by type
of store available from the Census of Retailing.

We also have seen no response to our recommendations that the pattern of data
collection be updated and improved. At present far too many resources are devoted to
collecting prices at the local level; there are thousands of price quotes for bananas in at least

40 different metropolitan areas. Yet bananas are imported -- how different can the price


129

As far back as 1961, the Stigler Commission recommended the CPI conform to a cost-of-
living index (COL. Recognizing that some parts of this change would be easier to accomplish
than others, I recommended, when in charge of the CPI and PPI at BLS, that the CPI be
characterized as a cost-of-living oriented index (COLO).’ In that way, the public would know the
BLS objective, but also that it would be reached as measurement of each various cost-of-living

facet became possible.

Of all the issues that must be addressed if the CPI is to be a better proxy for the COLI,
correction for substitution bias is, perhaps unfortunately, the easiest. That is why it could be
accomplished most quickly. It is unfortunate because it means that the BLS has corrected the
overstatement biases first, so the potential understatement biases posed by moving the CPI to a
COLI remain, and have fewer upward bias elements to offset them. Therefore, it is imperative that
the BLS move quickly to estimate other facets that comprise a cost-of-living index. Until it does,
there is a greater likelihood that beginning in 1999 the CPI may be understating inflation than

overstating it.

‘The first change needed, and the most obvious, is to correct the error in handling
environmental-related costs. In 1971, 1 recommended that the cost of a catalytic converter for auto

emissions be treated as a price increase, not a quality change. That recommendation was

¥See J. Popkin, “Problems and Progress in Improving Measures of Wholesale and
Consumer Prices,” Business Economics, May 1973, pp. 32-37.


113

basis. If the expenditure survey were improved, as suggested in the section on the expenditure
survey, above, it is likely that a frequently re-weighted Laspeyres index would also have very low
substitution bias (this seems likely from evaluation of alternative index number formulas for the
Personal Consumption Expenditures component of the national accounts). Thus, improvements
in the Consumer Expenditure Survey are necessary to implement effectively any option for
reducing CPI weighting effects and substitution bias.

BLS Research

‘Congressman Shays’ letter asked for suggestions for how Congress and the Administration could
work to improve the index. In responding to this very positive request, I emphasize that
researchers inside the BLS have developed most of the information that is now available on
upper level substitution bias and on the lower level index problem. Without the very active and
very professional research staff that exists inside BLS, economists would lack firm knowledge of
the sizes of potential biases in past CPI’s and what to do about them. I recall that when BLS
economists first began work on estimating substitution bias in the CPI, more than twenty years
ago, many economists were willing to “guesstimate” that the CPI substitution bias amounted to 2
to 3 percentage points per year. That we now have numbers, rather than guesstimates, facilitates
an informed debate on CPI measurement issues, and demonstrates the value of the BLS research
program.

BLS researchers have also demonstrated that they can make substantial contributions to better
methods for handling quality change in goods and services priced for the CPI. Quality change
was, rightly, emphasized by the Boskin Commission as a serious measurement problem in the
CPI, and it is recognized as a difficult problem. Improving quality change methods is probably
the most pressing need for moving the CPI closer to a measure of the cost of living, and
additional research on quality change promises a very great payout for improving the index.

Accordingly, assuring resources for continued research on measurement issues in the BLS is one
of the greatest contributions that can be made to long-run improvement of the CPI.

Summary

The BLS has made three recent positive changes that improve the CPI and move it closer to a
cost-of-living index.

First, it has updated the weights to a 1993-95 reference period, which means they are more
current than the former 1982-84 weights. That should reduce the size of the upper level
substitution bias, at least for the next few years.

Second, it has announced that the CPI re-weighting cycle, which has been ten to twelve years in
the past, will be shortened in the future. That means that CPI weights will never again become as
far out of date as they were before January, 1998, when they were roughly 14 years old.


122

oanenensarsnerensaeens.

The Heritage Foundation is a non-profit, educational, public policy research organization
operating under section 501 (c3) of the Intemal Revenue Service Code. It is privately
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During 1996, it had more than 200,000 individual, foundation, and corporate
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Members of The Heritage Foundation staff testify as individuals discussing their own
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position for The Heritage Foundation or its board of trustees.


127

Prepared Statement
of
DR. JOEL POPKIN

Joel Popkin and Company, Washington, DC
Before the
Subcommittee on Human Resources
Committee on Government Reform and Oversight
United States House of Representatives

April 29, 1998

This Committee has requested testimony on three issues regarding improvements in the

Consumer Price Index (CPI):

1. ‘What the Bureau of Labor Statistics (BLS) has already done;
2. What the BLS has decided to implement in January 1999; and,
3. What the BLS’ long range plans are to maintain the objectivity and accuracy of

price and cost-of-living indexes on a timely basis.

will briefly comment on (1) and (2) and provide my views about the direction of long-run plans.
But because written testimony before a congressional committee must necessarily be presented in
advance to Committee staff, it is quite possible that some issues I will raise have simultaneously
been addressed by the BLS at this hearing. And I am hopeful that today's BLS testimony will
already reflect some of the recommendations 1 will develop in this testimony. However, I should
note that I cannot find them in the BLS contribution to the Symposia on the CPI that appeared in

the latest issue of the American Economic Association's Journal of Economic Perspectives (JEP).


CONTENTS

Hearing held on April 29, 1998 .
Statement of:

Abraham, Katharine. Commissioner, Bureau of Labor Statistics, U.S.
Department of Labor, Edward M. Gramlich, Governor. Board of Gov-
ernors, Federal Reserve System; Robert J. Gordon, the Advisory Com-
mission to Study the chi, Northwestern University, and Bernard
Ungar, Director, Government Business Operation Issues, U.S. General
Accounting Office, agcompanied by Lauren Yager, Acting Chief Econo-
mist, and Kathleen Scholl, senior economist ....

Triplett, J Jack, visiting fellow-economic studies, the Brookings Institution:

jilson, labor economist, the Heritage Foundation; and Joel
Popkin, pee Joel Popkin and Co. ............-
Letters, statements, etc., submitted for the record by.

‘Abraham, Katharine, Commissioner, Bureau oF Labor Statistics, U.S.
Department of Labor, prepared statement of ..... 7

Gordon, Robert J., the Advisory Commission to Study ‘the CPI, North:
‘western University, prepared statement of ... .

Grambich, Edward M., Governor, Board of Governors, Federal Reserve

stem, prepared statement of

Poplin Joul president Joel Popkin and Go.” prepared statement of”

Sanders, Hon. Bernard, a Representative in Congress from the State
of Vermont, article dated October 6, 1995...

Triplett, Jack, visiting fellow-economic studies, the Brookings Institution,
prepared statement of .. .

Ungar, Bernard, Director, Government Business Operation Issues, U'S.

eneral Accounting Office, prepared statement of ..

Wilson, D. Mark. labor economist, the Heritage Foun
statement of ese

ae

Page
1

127
86

52
M7


106

difference between those indexes that gives you this estimate of the
substitution bias. So they both are weighted index numbers.

Now, ideally, if you just talked about the CPI system, what
weights would you really want in the Laspeyres index to produce
a price index for 1998? Well, the whole framework suggests that
what you'd really want, to be up to date, is 1997 weights. To do
the superlative index number people are talking about, what you’d
really want to do the price change between 1997-1998 is 1997 and
1998 weights combined.

The point I’m making here is that to do both the Laspeyres for-
mula that traditionally has been used in the CPI accurately and to
do the superlative index accurately, you ought to have weights that
are both accurate and up to date. Otherwise it’s not quite clear
what this substitution bias measure means. So, whether we're talk-
ing about a superlative index, or just updating the CPI, both accu-
racy and currency of the weights matters.

And that focuses some attention, I think, on the consumer ex-
penditure survey. The reason we use 3 years’ weights for the con-
sumer expenditure survey, the weights are now 1993-1995, the av-
erage of 1993-1995. The reason we do that is it’s quite a small sur-
vey. It’s only 5,000—the BLS says consumer units, but let’s say,
households, it’s roughly the same thing; 5,000 households and
that’s not big enough to weight the CPI so we use an average of
8 years. The BLS is proposing to increase that to 7,500 households
which would permit taking an average of 2 years.

One of the problems with an average of 3 years, we heard this
morning, is that it takes time to get the weights in. An average of
2 years also creates a lag. You probably could not ever eliminate
the lag for the reasons that Katharine Abraham indicated—it takes
a while to get the data in, takes a while to analyze the data—but
you could certainly shorten the lag if we were talking about pro-
ducing a CPI that is based on 1 year’s consumer expenditure sur-
vey. That would involve a larger expenditure survey, yes, in order
to get accurate weights. And | think there are some good reasons
why we should consider doing that.

Now, I also want to go back to put that proposal in context.
We're talking about 0.15 average bias here, and increasing the con-
sumer expenditure survey, say doubling it again, would cost
money. You obviously don’t want to spend a fortune to protect pen-
nies. But there’s a tradeoff here between accuracy and the expense
of producing the index.

And I want to point out that in the BLS proposal, if you cut the
reweighting cycle in half, by 2002 those weights would be 7 years
old. The maximum estimate of substitution bias that I’ve seen actu-
ally occurred in the old index when the weights were just about 7
years old. So cutting this timing lag, getting the weights even more
current, does have implications for the accuracy of the index. And
it does have implications for the accuracy of doing a superlative
index, which I support, or some of the other proposals that have
been made to get more complicated, let’s say, ways of estimating
the cost of living index carried out in the index.

Finally, this is again, on the future. I’d like to call attention to
the fact that all of the information that we have, almost all the in-
formation that we have, on upper level substitution bias, and all


66

objective and measurable. As BLS notes, the goals are generally expressed as significant

milestones expected to be accomplished during the given year.

Because of the way in which the goals are expressed, BLS’ performance indicators for
accomplishing the milestones are activity or output oriented rather than outcome
oriented. BLS notes this in its plan and says that, over time, it will show how its
indicators relate to desired outcomes, such as improving the accuracy of the CPI. The
use of output-oriented goals is allowed under OMB's guidance for implementing the
Results Act. The guidance notes that, although outcomes should be used whenever
possible, outputs may be used for several reasons, including when outcomes may not be
scheduled for achievement in the fiscal year covered by the plan. However, it appears to
us that the goals and indicators BLS cites in its performance plan are, for the most part,
‘changes to the CPI that BLS expects to complete in fiscal year 1999 that are aimed at
improving the CPI's quality. Thus, it would appear that BLS' performance plan would be
more fully responsive to OMB's guidance if the goals or indicators included an outcome
dimension to reflect the results of BLS' activities. Such outcome-oriented goals or
indicators could relate to improvements in the accuracy, efficiency, or relevancy of the

CPL.

Furthermore, BLS' goals and indicators could be more specific and quantifiable to enable
better stakeholder comparisons of actual results with established goals. For example,

BLS’ indicator for its performance goal to expand the Consumer Expenditure Survey (CE)

15


52

MAKING THE CPI MORE
REFLECTIVE OF CURRENT CONSUMER SPENDING

Summary of Statement by
Berard L. Ungar, Director
Government Business Operations Issues
General Government Division

The principal source of information on trends in consumer prices and inflation in the
United States is the Consumer Price Index (CPI), which is published by the Bureau of
Labor Statistics (BLS). To determine the level of inflation in consumer prices, the CPI
tracks prices for a fixed "market basket” of goods and services that urban consumers
purchase for day-to-day living.

As requested by the Subcommittee, GAO's testimony today addresses certain topics
related to the CPI. The first is the need for BLS to make the CPI expenditure weights
more current by updating them more frequently than at 10-year intervals, as GAO
Teported in October 1997. BLS uses expenditure weights to aggregate market basket
items into the overall index number. The preponderance of evidence GAO obtained
pointed to the need for and advantages of more frequent updates. This evidence included
the (1) views of professionals knowledgeable about the CPI, (2) practices of other
countries, (3) results of research that show that the age of expenditure weights affects
the CPI, and (4) the sizable effect more frequent updates could have on the federal
budget in comparison to the relatively small costs associated with updates. BLS has said
it agrees with GAO's recommendation for more frequent updates and is considering the
appropriate update frequency.

GAO also examined how well those elements of BLS' strategic plan and performance plan
that focus on improving the CPI would meet the criteria in the Government Performance
and Results Act of 1993 and related guidance, even though the BLS plans are not required
to comply with the statutory requirements. In examining BLS' fiscal year 1999
performance plan, GAO found that it was partially successful in providing a picture of
BLS’ intended performance to improve the CPI's quality. Further, the plan did not fully
portray how BLS’ strategies and resources would help achieve the performance goals for
improving CPI quality or how BLS would ensure that the data it uses to assess its
performance are credible.

GAO also reviewed the linkage between the goals in BLS’ strategic plan relating to
improving the CPI and the 1996 Boskin commission recommendations to BLS. GAO
found linkages between some, but not all, of the commission's recommendations and the
plan's performance goals and indicators. Neither BLS' strategic plan nor its fiscal year
1999 performance plan discusses such linkages or the lack of them. BLS and the
Department of Labor question the usefulness of discussing recommendations contained in
particular reports, such as the Boskin commission report, in long-range planning
documents. However, GAO believes such a discussion would enhance the plans’
usefulness and credibility to CPI stakeholders given the great interest shown in the
Boskin commission recommendations by Congress and others.


101

ommendations? Which ones you feel you should respond to, excuse
me, the Department should implement, which one’s they think they
shouldn’t, and give us a sense of how you're doing?

Ms. ABRAHAM. We have prepared a report that was submitted to
the Joint Economic Committee last June in response to a request
from Representative Saxton of New Jersey.

Mr. Suays. If you would just update that.

Ms. ABRAHAM. I don’t think that our views on these things have
changed. We could take a look through it and see whether it re-
quires——

Mr. Suays. I would like a letter to say that, if you want to have
a covering letter that just, there has to be some change in the year
because all good men and women learn new information and re-
spond to it.

Ms. ABRAHAM. We'll take a look at——

Mr. Suays. I would like that, and I’m going to end this question.
I want to know what the CPI truly tells me. I want to know how
up-to-date it is, and I’m going to really start with you, with Dr.
Scholl, I’m not saying your name, Scholl?

Ms. SCHOLL. “Scholl.”

Mr. Suays. Dr. Scholl, excuse me. I'd like to start with you and
go all the way down. I want to know if it is an up-to-date measure
of the cost of living, or whether it’s a 2-year? I want to have a
sense of what you think it tells me and tells the country. And, you
know, just some general comments about that. So, I'll start with
you.

Ms. SCHOLL. Weii, on the record, for GAO, we have not done that
much work about the cost-of-living aspects of the Consumer Price
Index. We've only issued a couple of reports. The only recommenda-
tion that we have is that it be updated more frequently which BLS
is basically addressing. Currently, they have just gone through a
major revision that occurred in January so it is pretty much closely
up to date as—

Mr. SHays. Yes, but what does closely up to date mean? That’s
what I want to know. When the CPI changes, is it really based on
data that’s 3 years old? Or is it really based on data that’s current
and tells me what truly happened last year?

Ms. SCHOLL. They use many different sources of data. The con-
sumer expenditure survey, which determines the weighting of how
much weight each item is going to have is based upon 1993-1995
data. It’s an average of those years that they use for weighting.
They use another set of data that they call a point-of-purchase sur-
vey, which is another aspect that’s fed into the index. They also col-
lect prices monthly of the items themselves. So it’s a grouping of
data from all sorts of different places in the economy or in the
United States that they compiled to produce the Consumer Price
Index. And like I said, for right now, since they just did a major
revision, it’s pretty correct.

Mr. SHays. I realize that you weren’t the person testifying, but
what’s instructive to me is that you're telling me how it’s put to-
gether, I’m asking you your opinion?

Ms. SCHOLL. I do not have a—GAO does not have an opinion.

Mr. Gorpon. I do.


26

implements a geometric-means formula to combine individual prices at the lowest level in the
index.
Although the CPI as currently constructed does not account for the upper-level

substitution possi

ies available to consumers, indexes that do take account of such
substitutions can be calculated; economists refer to them as superlative indexes because of their
desirable properties. Indeed, on an experimental basis, the BLS already produces superlative
indexes, but these indexes are only available with a considerable lag. In any case, using data
from recent decades, several studies have constructed indexes that take full account of consumer
substitution and have used these indexes as benchmarks to compare to the actual CPI. Through
such comparisons, it is possible to assess the amount of bias in the CPI arising from upper-level
consumer substitution. Although estimates depend on the time period considered and other
particulars of these studies, this research broadly suggests that correcting upper-level substitution
bias could be expected to reduce the rate of change in the CPI by about 0.2 percentage point per
year; for example, if the current CPI showed an increase of 2.0 percent over a year, then after
correcting for this type of substitution bias, the CPI could be expected to show an increase of
about 1.8 percent. Although this might not sound large, a bias of this size compounding over
many years has marked implications for any program or contract that is linked to the CPI.
Reducing Upper-level Substitution Bias

To correct fully for upper-level substitution bias it would be necessary to know the
composition of market baskets each month, in order to capture the substitution among different
items. The expenditure data required for such calculations are obtained from the Consumer
Expenditure Survey. And, because of collection and processing time, these data are only

4.


22

There is one other issue I'd like to raise and that is that even
the best real time approximation to a superlative index would not
match the superlative index that would ultimately be constructed
once the expenditure share data became available.

To deal with this problem, the Boskin Commission suggested
pursuing a two-track approach. For the first track, BLS could con-
tinue to publish a monthly index in real time that would never be
revised. This index would be much like the current CPI, except
that it could be based on aggregation formulas that minimize
upper-level substitution bias. For the second track, BLS could pub-
lish, with a lag, a superlative index that incorporated full informa-
tion on changing expenditure shares and that could be revised sub-
sequently to incorporate other improvements to the CPI as well.

This two-track approach has advantages and disadvantages. On
the positive side, the two-track approach would provide indices for
users with divers need, a never revised index for those for whom
revisions would propose operational difficulties, and a revisable
index that would be the best possible measure of changes in the
cost of living. On the negative side, the publication of two different
price indices might generate confusion. If that confusion were
judged to be a serious problem, BLS could alternatively produce a
single measure that was revised and ultimately incorporated all in-
formation in the best possible way. Were this to be done, Govern-
ment and private contracts that are linked to the CPI would have
to alter their indexation procedures, something that I don’t think
would be a particular problem.

But returning to the primary message, a study of substitution
bias and an outside review panel holds the promise of forming the
basis of a reasonable professional consensus on limited technical
changes that would correct this upper-level substitution bias, and
make the CPI a more accurate measure of the cost of living. Such
a consensus, I think, is critical for maintaining public support and
confidence in our statistical programs.

Thank you very much.

(The prepared statement of Mr. Gramlich follows:]


105

The committee has requested discussion of three issues: the 1998
changes to the CPI, which is primarily, I think, the weighting
changes; the proposed 1999 change to the geometric mean, for the
lower level indexes; and long-run changes to improve the CPI. I
want to summarize my reaction to all three of those. More details
are in my prepared statement.

First, the updating of the weights. That’s clearly an improvement
in the CPI. The old weights were 1982-1984 average. The new ones
are 1993-1995 average. That updates the weights, makes them
more nearly current, let’s put it that way. And it’s clearly an im-
proved measure and so that’s an improvement in the CPI as of
1998. As part of that the BLS has indicated that it would cut the
reweighting cycle in the future, which has been roughly 10 or 11
years in the past, to, we’ve heard this morning, something in the
order of maybe half of that. Cutting in half that reweighting cycle
would also, I believe, improve the CPI because, again, it would
make the weights more nearly current. When the old weights were
replaced this year they were roughly 14 years old, and the new pro-
posal would mean they would grow to perhaps a maximum of 7
years old and that’s clearly an improvement to the CPI. So I think
both the 1998 changes and the announced future changes are defi-
nitely in the right direction.

Second, the proposed 1999 change to the geometric mean. The
geometric mean replaces, the member of the subcommittee had this
formula that he was showing us, replaces the old arithmetic mean.
It’s been demonstrated clearly that the arithmetic mean has sub-
stantial flaws, and so I support moving to the geometric mean as
a way to get around some of those flaws.

In my prepared testimony, I talk about some technical matters
that I think are not quite resolved yet. But that’s a call for more
research, and I think this issue might need to be revisited in the
future. But, clearly, as an interim step, I think this is a step for-
ward, to move to the geometric mean.

Now, on long-run changes to improve the CPI. First, let me talk
a little bit about this issue of the substitution bias. We've had a
lot of talk this morning about the substitution bias.

In the first place, the Boskin Commission estimated it at 0.15
percent annually. This is not a huge number, 0.15. So I think that’s
the context in which we're talking about substitution bias. It is
true, however, that some of the research shows that in some
years—that was an average number across this whole period in
which the weights are fixed—for some years it has been consider-
ably larger. My reading of the evidence suggests there are some
years in which it reached roughly half a point, 0.5. And that’s a lit-
tle bit more concern, it seems to me, for everyone.

I think I'd also like to emphasize how you get this estimate of
substitution bias. The way you get it is to compute the formula
that the CPI now uses to aggregate those upper level components,
those 211 components. You compute the CPI’s formula, which is
technically known as the Laspeyres index, and then you compute
another formula which allows for substitution. So the way you do
it is you compare two index number formulas, both of which have
weights, and they have different weights. And it’s looking at the


34

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 1

Slightly more than three years ago, on March 11, 1995, the possibility of an upward
bias in the CPI, and its implications for the indexation of Social Security and for the Federal
budget, were suggested in testimony to the Senate Finance Committee by Alan Greenspan.
After further testimony by government officials and academic experts, that committee
established the Advisory Commission to Study the Consumer Price Index, better known as
the "Boskin Commission." The Commission issued its final report in December, 1996, and
was disbanded after a further round of testimony in early 1997.

In my brief remarks today, I will summarize the main elements of the debate set off
by the Boskin Committee report, including several of the substantive criticisms and our
response to them. Then, after acknowledging the changes thus far made by the BLS in
response to our recommendations, I will review the most important of the remaining
recommendations and what specific steps the BLS might take to implement them.

Our report identified four sources of upward bias in the CPI and estimated values for
the extent of bias attributable to each category. ‘These were upper-level substitution bias
involved with the way in which the 200 item categories are aggregated, lower-level
substitution bias occurring within the 200 categories, outlet-substitution bias created when
the CPI ignores price reductions achieved by consumers shifting to discount outlets, and the
most important category, bias created by inadequate allowance for quality change in existing
products and the benefits to consumers created by new products. Our final report estimated
values for these four sources of bias of 0.15, 0.25, 0.10, and 0.60 percent per annum,

respectively, for a total upward bias in the CPI of 1.1 percent per annum. We recognized


115

Mr. SHays. Thank you very much, Dr. Triplett.

Mr. Wilson.

Mr. WILSON. Thank you, Mr. Chairman, members of the sub-
committee. In the interest of time, I'd like to submit my written
testimony for the record, but I’d like to also point out that——

Mr. SHays. Let me just say something, sir. You had to wait a
while so you feel free to make——

Mr. WILSON. That’s fine.

1 Mr. Suays [continuing]. I’m happy to have you summarize but

Mr. Witson. I think there’s a lot of things that have been dis-
cussed. There’s no reason to go over a lot of the points ——

Mr. Suays. OK.

Mr. WILSON [continuing]. That have already been made——

Mr. SHAys. Sure.

Mr. WILSON [continuing]. So I'd like to just touch on briefly ——

Mr. Suays. Sure.

Mr. WILSON [continuing]. The points that I think probably
haven’t been touched on sufficiently so far today. Well, we all are
aware that the Consumer Price Index is one of the two most impor-
tant economic statistics produced by the BLS. The other one, of
course, being the unemployment rate. It’s important because it is
a central target of monetary policy, and that’s why Chairman
Greenspan is so interested in it. But it also is important because
it significantly affects a wide variety of other Government data,
and, heretofore, the public policy debates that surround such things
as real wages and income growth. To give one example, if you be-
lieve the previous formulation of the CPI overstated inflation by
approximately 1 percent a year from 1973 to 1975, real hourly
wages would have actually increased over that period of time rath-
er than having decreased as currently reported. So getting the Con-
sumer Price Index as accurate as possible is important not only be-
cause it plays a significant role in monetary policy and has signifi-
cant implications for the Federal budget, but also because it would
significantly and substantially affect the public policy debate in
this country.

Since 1990, the BLS has implemented a variety of improvements
in addition to its 6-year CPI revision program. And many of those
have been touched on by Dr. Abraham this morning. The effect of
these improvements, combined with the major CPI revision, will ef-
fectively reduce the rate of increase in the CPI by almost 0.7 per-
centage points per year and will save taxpayers about $100 billion
a year in Federal outlays and interest payments between now and
fiscal year 2003.

In fiscal year 1998, I'd like to point out the BLS——

Mr. SHays. Let me just interrupt you. The interest payments are
the result of what in terms of the index? What comes down?

Mr. WILSON. There is the interest rate premium obviously, ex-
cuse me, there’s an inflation premium on all interest rates, even
Government bonds, to the degree that the public and the markets
perceive measured inflation as being the bulwark of interest rates.

Mr. Suays. But that’s determined by the market, that’s not——

Mr. WILSon. Right.

Mr. Suays. That’s not determined by the CPI?


136

Mr. Suays. Yes, sir?

Mr. PopKIN. I would just tack on to that, that information can
be collected. The kind that we need. It’s more expensive but, to do
it, but it can be collected.

Mr. Suays. Let me just go to the gentleman 1 second. I just say
that one of the observations that I made the last time we had BLS
before us is what an extraordinarily important responsibility to
have, and what an ignored agency on the part of Government in
terms of the appointments of them, of the people, the commis-
sioner, and so on, the significance of that appointment, and also
the need to make sure they have the best staff and the resources
necessary.

And it strikes me that there’s a lot more that BLS could be doing
that would be helpful. A new Congress and a new President, I don’t
mean Republican or Democrat, I just mean new, may say “There’s
a lot more we want you to do because we want to break up the in-
come levels and we want to have a cost of living for one income
level and a cost of living for another, a CPI for one and a CPI for
another, and one for the elderly, and determine how Social Security
is impacted particularly for the elderly with one on them.” Is that
something that conceivably we would want to move toward?

Mr. TRIPLETT. My suggestion would be that, what would seem to
make sense, one would do a pilot, some sort of pilot study, and see
how much difference it makes, you don’t have to do the whole thing
full blown. Katharine Abraham, this morning, said that would real-
ly be expensive. I think she’s probably right. But you probably
wouldn’t want to do the whole thing full blown, you’d want to have
some pilot and then you could compare the results of the pilot.
Maybe in Florida or some area where you've got, don’t have any
problem collecting prices for things that elderly buy or Social Secu-
rity recipients buy. And just see how that moves. Do it right for
some small area in a pilot. See how it moves and then make your
decision after you’ve got that pilot as to whether or not this is
something that we want to put public funds into.

Mr. Suays. Thank you very much. Mr. Towns.

Mr. Towns. Thank you very much, Mr. Chairman. I thank you
very much for your comment because that was the question I was
going to ask. I really appreciate you in terms of your views on that.
The Congressional Budget Office has estimated that one half per-
centage point change in the CPI could result in a deficit reduction
of approximately $25 billion. And, of course, 5 years after the alter-
ation, 40 percent of that savings will be in program reductions, and
60 percent will be in increased taxes. Can you tell us what is the
likely effect these changes will have on the overall economy?

Mr. WILSON. Certainly reduced interest rates, interest rate pre-
mium and the market will go down. That will certainly improve,
in my opinion, improve the real rates of productivity and economic
growth in the long run.

Mr. PopKIN. Could I comment on that? I’m not so sure, and this
relates to a comment Mr. Wilson made earlier in his testimony.
The inflation rate is running about 2.5 percent per year on the old
basis before the BLS puts in these 1999 improvements. The short-
term interest rate, the interest rate on a 3-month Treasury bill is
about 5.5 percent, or 5.25. That means that the spread is almost


58

would have been $2.4 million spread over 3 years. According to BLS, the estimated cost
to update the expenditure weights in 2003 would be $3.1 million over a 3-year period. In
comparison, BLS reported that the major CPI revision in 1987 cost $47 million over 5
years and, at the time of our report, expected the cost of the 1998 major revision to be
about $66 million over 6 years. BLS explained this difference in cost by pointing out that
an update of the expenditure weights would exclude many activities that are included in

major CPI revisions.

More Frequent Updates Could
Affect the Federal Budget

Because federal tax brackets and federal payments, such as those to Social Security
beneficiaries, are adjusted for inflation, a CPI that more accurately measures inflation
could affect the federal budget. BLS estimated the annual range of change in the CPI, if
the expenditure weights were updated on a 5-year cycle, from 0 (zero)-no change-to a
decrease of 0.2 percentage point. We asked the Congressional Budget Office (CBO) to
use the midpoint of BLS' range (a decrease of 0.1 percentage point) to estimate the effect
‘on the federal budget. CBO estimated that, assuming no other changes in policy or
economic assumptions, if updating the weights in 2003 (5 years after the 1998 major

revision) reduced CPI growth by 0.1 percentage point annually, the projected budget


112

interpretation.

Having said this, 1 emphasize that I support the BLS move to geometric means as an interim
improvement to the CPI. Itis an interim step because the “lower level” index number problem is
one that has emerged only recently and the issues are still not fully understood. In contrast, the
“upper level” substitution problem is one where theoretical and empirical economic research has
a long history and the issues are well settled,

Other Points on Substitution Bias

Other options for moving the CPI weighting closer to a cost-of-living index have been discussed.
‘One is to change the index from its traditional Laspeyres formula to a superlative formula, such
as the Fisher index. Superlative formulas require weights for the current year (for example, a
measure of price change for 1997-98 would require weights for both 1997 and 1998), but current
year weights are not available until after the publication month. Superlative index number
formulas could only be used in the CPI if the index were routinely revised, retrospectively, as the
new information becomes available.

Revisions to economic time series are never liked, no matter what series is revised, and the CPI
has no tradition of revision. Yet, there is no particular reason why we tolerate revisions to
national accounts when the revisions improve the accuracy of the information and do not tolerate
them in the CPI. Many escalation arrangements that use national accounts information exist in
the United States, and users have evolved methods for escalation with indexes that are revised.
Accordingly, the escalation uses of the CPI do not seem an overwhelming reason to reject
revisions, provided assistance is provided to users who may be unfamiliar with escalation
contracts where the escalating index is revised.

Another proposal is to estimate or forecast the change in a superlative index number, using
Consumer Expenditure Survey information and some form of weighted geometric mean index at
the upper level. That is, one could combine the 211! strata of the CPI (most of which will be
computed from geometric means, after 1999) with an expenditure-weighted geometric mean
index. The intention, here, is to reduce the difference between the Laspeyres formula and the
superlative formula, thereby reducing potential CPI revisions (from the first option discussed
above) and/or surmount the problem that current-period expenditure data are not available to
compute the superlative index.

Both these proposals deserve consideration, Whether or not the official CPI is converted to a
superlative index on a current basis, an alternative or research superlative index should be
published as an analytic aid in evaluating the official index.

However, these proposals imply that CPI weighting information is available on a more current
basis than is presently the case. The proposals, in other words, require an expanded and
improved Consumer Expenditure Survey, so that weights could be incorporated on a timely


16

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Moving Forward

To spur progress on this issue, about which there appears to be considerable agreement,
one approach that this Subcommittee could consider would be to commission a study of
substitution bias to be undertaken by the staff of the BLS. The BLS could be asked to compare
their current procedures with those that have been proposed by other researchers. Specifically, 1
would suggest that they determine which of these alternative approaches provides the most timely
and accurate approximation to the “superlative” indexes published by the BLS, recalling that,
while these superlative indexes may be the “best,” they are available only with a considerable lag.

In evaluating the alternatives, the objective should not be to establish a “perfect” measure--such a
goal is unattainable. Rather the objective should be to produce the best measure of the cost of
living that can be constructed in real time from existing knowledge and data.

At the same time, the Subcommittee could establish a formal panel of outside experts to
review the BLS's evaluation of the alternatives and to provide an independent assessment of the
BLS study to the Committee. The panel could also consult with the research staff of the BLS on
the design of the study and the interpretation of the results, If differences remained after
completion of the study, the panel of experts would provide a mechanism for independent
assessment of alternative approaches that could be helpful to this Subcommittee's oversight
responsibilities.

A Two-Track Approach

Let me raise one further issue that would inevitably arise from such a study. Even the
best real-time approximation to a superlative index would not match the superlative index that
ultimately could be constructed once expenditure share data ultimately became available. To deal

-6-


94

I have to tell them that this is just all, you know, a mathematical
model they’re using. And what I’m telling you is that you have
really confirmed for me the importance of Congress looking at the
implications of your purely mathematical calculations because if,
you know, I note that you’re taking——

Ms. ABRAHAM. That sounds right.

Mr. Kucinicu. Right, I understand that, I note that you're taking
computers and modems and other things into some of the calcula-
tions. Well, you know, I can appreciate all that but at the same
time I started off my remarks, Mr. Chairman, by talking about the
human context here, and the human dimension and while I can ap-
preciate the technical expertise of everyone sitting in front of me,
and I do, I also want it said that you’re not divorced from politics
and you may try to be and I appreciate your conducting yourself
in that way, but you’re not because your conclusions are not.

Mr. Gorpon. Let me address something that is a legitimate, pos-
sible concern, and this has to do with the distribution of income.
We all know that the mean is different than the median. As I un-
derstand it, the BLS consumer expenditure survey weights these
different categories by total expenditure, and that means that rich
people have a bigger vote in dollars than the por people in deter-
mining the weights within the CPI. You could urge or require the
BLS to adopt a different concept which is to have a survey that is
focused on the median-income family and their patterns of expendi-
tures and you would get a slightly different answer. I don’t think
it would make any difference in the rate of inflation but it would
be a slightly different set of weights.

Mr. KUcINICH. But wouldn’t you agree, sir, that you look at the,
that with tax brackets and so-called deductions currently indexed
to the CPI, a lower measured rate of inflation would lower the
bracket cutoff point relative to where they would have been with
the current CPI and lowered the size of the standard deduction rel-
ative to where it would have been and both of these factors expose
more of a person’s income to higher tax and this would——

Mr. GorDON. That’s correct, that——

Mr. Kucinicu [continuing]. Essentially, thank you——

Mr. GorDON [continuing]. Thirty-five percent——

Mr. KUcINICH. Well, it would especially affect the middle-class
where there are more tax bracket distinctions and they use stand-
ard deductions probably more frequently than high income earners
who itemize. So that’s why I raise this issue.

Mr. Gorpon. Sure, we all agree with that.

Mr. Kucinicu. OK, thank you. Mr. Chairman.

Mr. Suays. Thank you. I’m going to recognize——

Mr. Towns. I just want to make a brief comment. Basically, Mr.
Chairman, I know that when we talk about changes, generally we
talk about more resources. You know, I’m not sure that we should
be involved here in any kind of legislative recommendations or
changes or involvement in this point in time. However, I must
admit that I’m uncomfortable over the fact that some pilot projects
are not going on to sort of answer some of the specific kinds of
questions that we have. And I think that if that requires additional
resources to do it, then there’s some things that we need to do. I’m
concerned about our senior citizens. And I’m concerned about the


9

are also actively reaching out to others in the academic community,
and on the staffs of statistical agencies around the world.

Unlike the specific activities that I already have described, how-
ever, it’s much more difficult to say what future improvement pos-
sibilities might be identified or on what schedule. I can only tell
you that we will be aggressive in pursuing such possibilities and
in applying our best technical judgment concerning their adoption
in the index.

Thank you.

{The prepared statement of Ms. Abraham follows:]


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83

just to see if you get big differences. Right now those people who
have studied the issue, don’t seem to get big differences. But that
is something that could be checked more carefully if you had—if
the BLS, let say, on a one time basis, went back and did these
high- and low-income families.

At the same time, I think we should all be mindful of the fact
that we are balancing resources. And I have some sympathy with
what Bob Gordon just said that there are other high priority issues
out there and it may be that this isn’t the highest. So it could cer-
tainly be on the table.

Mr. Uncar. Mr. Towns, I'd just like to point out that one of the
basic purposes of the Results Act is related to this discussion that
we're having now. It’s for the agencies to lay out for Congress, and
others, what they see as important results they would like to
achieve over, in a strategic plan over a 5- or 6-year period, how
they’re going to get there, what resources they’re going to use, and
how they’re going to measure how they perform. It’s to lay this in-
formation out as a proposal linked to its budget for the Congress
to look at and decide whether it thinks the agency is going in a di-
rection that it would feel comfortable with. If not, then Congress
can raise those questions as you are now with the appropriate
agency. So I think the Results Act does provide a useful mecha-
nism for this type of discussion and you might want to pursue that
at some point.

Mr. Towns. Thank you very much. How do you change the demo-
graphics that affect the CPI? As the population grows older, should
the CPI devote more weight to maybe health care cost and less to
shelter or less to something else? We're living longer.

Ms. ABRAHAM. This relates to the. questions that Mr. Sanders
was bringing up earlier as well. Perhaps I could just describe what
the CPI is and then what it isn’t. What the CPI is attempting to
do is to track the cost of the market basket purchased by the aver-
age consumer. So we take all consumer expenditures, we look how
those are allocated across categories and, based on those weights,
we weight up the price increases in individual components. I think
it is a quite legitimate question to ask, whether it would be useful
for us to produce indexes for a broader array of groups, CPI’s for
the elderly, CPI’s for people in different income groups. We have
done some of that on an experimental basis, and I may not have
been understanding your earlier question. We have an experi-
mental CPI for the elderly. We’ve done some research on looking
at CPI’s for poor households as opposed to average households. Dr.
Gramlich’s comment that, at least with respect to the poor, our ex-
perimental measure didn’t look a lot different than the average
measure is correct. But I do want to draw a distinction between
what we do and the array of measures that we might potentially
produce and decisions that are really policy decisions about how
those measures get used, and those are obviously distinct things.

Mr. Towns. I understand that the CPI makes certain economic
assumptions, I am concerned about the effect of the CPI on the
poor. Does the Department have a way to look at the relationship
between anti-poverty programs and the CPI? Is there a separate
index, inflation, and it’s among this population upon which to de-
termine whether certain things are working?


5

some who disagree with me, that, in fact, because elderly people
are more dependent on health care, and because health care costs
have gone up faster than the general rate of inflation, I would
argue that, in fact, current CPI’s are underestimating, under-
estimating the needs of our senior citizens and should be raised,
certainly, not lowered.

But, Mr. Chairman, I want to see fast statistics. I want to see
Dr. Abraham and the others come up to me and tell me how much
more it costs senior citizens in the State of Vermont, or in Con-
necticut, or in New York this year as opposed to last year, based
on their needs, not on some 18-year-old kid in a warm weather cli-
mate. And then we can debate that. But I will vigorously oppose
any back-door effort; I mean, I’ve seen it—what a cheap way, what
a disgraceful way to save Government money, because it’s only a
half percent, gee, we're taking $100 away from somebody in Cleve-
land, OH. Who’s going to know the difference? You multiply by it
all the folks, we’ve saved billions of dollars and we can give it to
the billionaires in another tax break. That is an outrage. And I will
fight that tooth and nail. So I would hope you will come up with
fast statistics to the people who are affected. You'll have to tell me
before you cut one nickel, and I think you should raise the CPI,
you'll have to tell me what the costs are this year and next year
for elderly folks in the State of Vermont who are highly dependent
on health care.

Thank you, Mr. Chairman.

Mr. Suays. | thank the gentleman at this time, and we will get
to the panel after Mr. Kucinich makes an opening statement.

Mr. KucinicH. Thank you very much, Mr. Chairman. I’m glad I
came here in time to hear Mr. Sanders’ remarks because, Mr.
Sanders, I’m cure you understand that somebody has to be here to
represent billionaires, and corporate welfare, and B-2 bombers,
and tax breaks to the rich. It’s not going to be you, but it’s not
going to be me either, but we recognize that somebody has to rep-
resent them and speak for them. So the record duly noted that
they’re included in all the discussions and debates here.

I’m pleased to see that the subcommittee continues to take a
careful look at the Consumer Price Index, and any changes that
are being considered or implemented by the Bureau of Labor Sta-
tistics. We do have a respected group of witnesses with us today
from Government agencies, and research institutes and I welcome
them to our deliberations.

When we talk about the CPI, there’s a tendency to get wrapped
up in details of statistical methods, the accuracy of economic pro-
jections. Those discussions are necessary, of course. I have con-
fidence in the professional approach of the Bureau of Labor Statis-
tics in evaluating all the relevant data. However, we must never
lose sight of the true importance of the CPI, what I would call the
human dimension of the CPI because the calculation of the Con-
sumer Price Index has a direct impact on the lives of millions of
Americans, especially the most needy among us. As we all know,
the CPI is our Government’s primary index for adjusting the pay-
ments made in a number of critical Government programs. The
CPI affects the payments to nearly 45 million people who receive
Social Security, and another 3.4 million veterans and their sur-


lll

4

Survey is small by international standards. Canada, for example, includes about 36,000
households in its consumer expenditure survey (though the data collected in the Canadian survey
are not as detailed in some cases as in the U.S.)

Even estimates of substitution bias require accurate weights. Substitution bias is often estimated
by comparing the Laspeyres index formula used in the CPI with the results of another formula,
such as the Fisher index. The Fisher index uses weights for two periods, rather than one. An
accurate measure of the true difference between Fisher and Laspeyres indexes requires accurate
weights for both indexes. When weights are inaccurate, the difference between Fisher and
Laspeyres indexes may just measure statistical “noise.”

The BLS Change to the Geometric Mean for Lower Level (Item Strata) Indexes

BLS recently announced that the statistical estimator used for most lower level indexes, or item
strata indexes, will be changed to a geometric mean estimator in January, 1999. Examples of
item strata indexes are “bananas,” “sugar and artificial sweeteners,” and “college tuition and
fees.” The change to the geometric mean was recommended by the Boskin Commission.

1 support the change to a geometric mean as an interim step to improve the accuracy of the CPI.
However, I believe that this issue needs more research and might need to be revisited in the
future.

Almost all of our knowledge about the lower level index number problem in the U.S. CPI comes
from research by BLS staff, who were secking to improve the index. Outside reviews, including
the Boskin Commission, have added mostly interpretations of the BLS research. But some
aspects of the interpretation are still in doubt.

What we know at this stage is that the old BLS estimator for strata indexes (sometimes called an
“arithmetic mean”) is seriously flawed, and that the geometric mean gives a different answer.
‘The size of the difference between arithmetic and geometric mean estimators depends on the year
for which the difference is estimated, and on the exact comparison that is made, but it is
somewhere in the neighborhood of 0.2 percentage points per year.

The Boskin Commission labeled the difference between arithmetic and geometric mean
estimators “lower level substitution bias.” In my opinion, “lower level substitution bias” is part
of the interpretation of the research findings, but itis an interpretation that is incomplete. The
geometric and arithmetic mean estimators for the price index for bananas, for example, are
different, but there is no consumer substitution among different kinds of bananas because
bananas in the United States are as close to a homogeneous commodity as can be found. We
need more research on how consumer shopping, search, response to store sales, and so forth
should be handled in a cost-of-living index. I have recently written on this, as has Prof. Robert
Pollak, of Washington University. The lower level substitution bias interpretation of BLS
research emphasized by the Boskin Commission is not wrong, but it is not a complete



81

Mr. SHays. So, is there about a year’s lag in terms of the—

Ms. ABRAHAM. So, there’s about a year’s lag in us getting it, and
then historically there has been a further lag given the nature of
our processing systems, in getting it in place.

Mr. Suays. OK, so the answer is not, no, it’s really, yes. 1 mean,
there’s a lag in terms, there’s the issue of how you weight and but
there’s also an issue of the data that actually goes in, so once you
have——

Ms. ABRAHAM. Right.

Mr. Suays [continuing]. And that’s the point. And so you're say-
ing it’s about a 2-year lag?

Ms. ABRAHAM. Well, at present, we are getting the data in about
2 years after the most recent data we're using have been collected.
But also, given the size of the survey, to ensure a sufficiently high
degree of statistical accuracy in the estimates, we're currently
using 3 years worth of data which is why, on average, the market
basket is 342 years old at the time we introduce it.

Mr. Suays. My time is really running out here, and we'll go
around again. But would others comment to this issue?

Mr. Gorpon. I think if there were a plan to do regular updates,
the computer systems could be designed to simply plug in the new
weights.

Ms. ABRAHAM. And we are doing that, we are doing that.

Mr. Gorpon. Right, and, so, you know, in Japan they can do it.
I’m sure there could be, in principle, some kind redesign of the pro-
cedures that would allow——

Ms. ABRAHAM. And that is part——

Mr. Suays. No, just let him finish, let him finish. I’ll let you re-
spond. I mean, my intention is not to have a big debate but to
know the facts when we’re done.

Mr. GorDon. So, I think there’s agreement here——

Mr. Suays. Yes.

Mr. Gordon [continuing]. That it is feasible to do it faster. I
don’t think there’s any clear sense that it makes a huge difference
whether you do it every 5 years or every year. I think that’s prob-
ably one of the least ——

Mr. Suays. OK.

Mr. GorDon [continuing]. Important of the Boskin Commis-
sion—

Mr. Says. Yes, what I want to make sure is in the end when
we're done, when we think we’re done, if we’ve missed the big issue
so we need to have you just tell us and then I want to explore this.
I don’t want to end this hearing and find that we're on the edges
of what we think is important.

Mr. Towns, and then we'll go right down through our members
and then we'll just go through again.

Mr. Towns. Thank you, Mr. Chairman. Let me begin by thank-
ing the witnesses too because this is something, as indicated, we
need to really know more about. And I think the chairman sort of
hit upon the fact that, are we giving it the kind of support that it
really needs in order to be able to do the kind of things that we
feel that it should do in terms of resources. And along those lines,
Td like to know if the Department could produce some kind of


107

the information we have on this lower level problem, has been pro-
duced by BLS researchers. Researchers inside BLS have produced
all of the information that we really have. And, therefore, an impli-
cation for improving the index, in the long run, it seems to me, is
that one of the most important ways we can assure continued ex-
cellence in the CPI, and improvement in the CPI, is to support that
research program that has developed so much information that
now helps us assess the accuracy and comprehensiveness of the
measure.

Thank you.

(The prepared statement of Mr. Triplett follows:]


92

Mr. GorDON. I wanted to make a couple of comments on the gen-
eral line of questioning. First of all, you don’t necessarily have to
index Social Security by the CPI. Several of our commission mem-
bers actually have suggested in public that a more appropriate
measure for indexation would be wages so that the income of the
retired kept pace with the income of the working people. What
index of wages and whether that’s a correct measure is a whole dif-
ferent issue. That might be a more useful way to go than spending
all the money to do a separate CPI for the elderly.

Everybody agrees that the main reason why inflation for the el-
derly might differ has to do with medical care inflation and infla-
tion of prescription drugs. As a matter of fact, there has been a
huge change in this country over the last 6 years from a time in
1992, when medical care inflation was running 3 whole percentage
points faster than overall inflation to 1997, when general inflation
and medical care inflation had converged to the same low rate. So
you would get a different answer to this question about inflation
for the elderly depending on what point in time you looked at it.

Mr. Suays. Mr. Kucinich, you are a very gracious man, and very
patient, but you knew that you would have your time and some.

Mr. KucInicu. No one’s heard my questions yet, so.

Mr. Suays. OK, you have the floor.

Mr. Kucinicu. Thank you very much, Mr. Chairman, for your
kindness for holding these hearings. So much of this discussion ap-
pears to be very clinical and oh so apolitical. For a moment I would
think that we were transported in time and space and we weren’t
in Washington, DC. [Laughter.]

That I was in some rarified Ivy League tower having some dis-
passionate discussion about the mating habits of the tsetse fly. I
mean, let’s get real here. Social Security is a big issue right now.
There’s speculation, there are some people who want to privatize
it. There are others who will say that it’s going to run out of money
in the year 2029, or have 75 percent of its capability. It would seem
to me perfectly logical, given the hysteria thats been raised, that
some mysterious process would be at work to get the CPI lowered
so you don’t have to pay out as much. I mean, wow, big surprise
but we’re in Washington, things like that could never happen. I
mean there’s, I mean, we need to puncture this unreality that
comes up here, Mr. Chairman. Frankly, with all due respect, I as-
sume that you're all fine public servants and I thank you, and I
want that noted in the record. But really to come here in front of
this committee, at least in front me, I believe I have a different
view of the way the world works, I have to tell you something. It’s
not real for you to tell us that this is all divorced from politics.
Now, I mean, please, you know, please.

The thing that I'm wondering, you know, I’ve been looking at
this, there’s a formula here somewhere, OK. This is the formula,
you have a, the old formula was an arithmetic mean and the new
formula is a geometric mean. I’m sure all of you are familiar with
that, right? I have, I’ve been looking at this and listening to this
real hard, and because the real issue in this country is how the
wealth is redistributed, and I’m going to get into a few questions
about the impact of that on your deliberations. But, let’s see, the,
here it is, I’ve got the old formula for the redistribution of wealth


60

index formula to construct the CPI, although BLS believes the recommendation did not
specify how a true superlative index might be constructed. Moreover, BLS does not view
the superlative index as a replacement for the fixed market basket index, and said it

would continue to publish the fixed market basket CPI.

In commenting on GAO's recommendation, the BLS Commissioner said she supports
more frequent updates of the expenditure weights. However, she said neither economic
theory nor empirical evidence demonstrates the superiority of any particular update
interval. This has been the principal reason why BLS has not updated the expenditure
weights between major revisions to the CPI. Other reasons cited by BLS included
difficulties in obtaining funds to bring about change to the CPI and concem with what

would be the best approach to improve the CPI.

Although theoretical guidance is not available on all facets of updating expenditure
weights, such as exactly how often updates should occur, the preponderance of the data
we reviewed supported the need for updating expenditure weights more frequently than
approximately every 10 years. Recognizing that the data are not perfect and do not
isolate the effects of using outdated expenditure weights, comparisons of price indexes
with old and new weights that go back to those made for the first revision in 1940
indicate that price indexes computed with more current weights were always different

from indexes computed with older weights. These comparisons and more recent research


56

effect on the federal budget of more frequent updates, and (5) BLS' response to our

recommendation that it should update the expenditure weights more frequently.

We spoke with 10 individuals who were former officials of BLS or who had otherwise
studied the CPI, and they were unanimous in stating that 10 years between updates of the
expenditure weights was too long. However, there was less agreement among the
individuals on exactly how often the updating should occur. Five, including the chairman
and three members of the Boskin commission, said more frequent updating of
expenditure weights was less important than other ways of making the CPI more
reflective of current consumer spending. Dr. Boskin told us that if there were no changes
in existing products or no new products in the economy, then updating the expenditure
weights would be the only step that BLS would need to take. However, since the
economy does change, with new products being developed and product improvements
occurring constantly, he believed more frequent updating was only one step among a

number that should be taken to improve the CPI.


18

priced items, the objective being to bring new goods and

services into the index on a more timely basis.

In summary, Mr. Chairman, with the support of Congress and
the Administration, the BLS has been able to make
substantial progress in improving the accuracy and
relevance of the Consumer Price Index. Certainly, more can
and will be accomplished. But, just as certainly, further
progress depends critically on the continued support of
those making decisions about the Federal budget. Our
success in improving the CPI also depends on the public’s
continued belief that our decisions about the construction
of the index are arrived at independently and impartially,
using the most appropriate techniques available to us.
Preservation of that independence and impartiality should

be important to all who depend upon the CPI.


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51

either direct or indirect linkages from our perspective to the other
five. We believe it would be helpful for BLS, in its next plan, to
at least discuss the linkages, or lack thereof, between its plan or
the goals in its plan and the Boskin Commission recommendations.
BLS has some concerns about that but we, nevertheless, believe it
would be helpful to have such discussions.

(The prepared statement of Mr. Ungar follows:]


80

Ms. ABRAHAM. I don’t think it is actually a “no-brainer” that you
would want to do it continuously. There are those who have sug-
gested that perhaps you might want to update the market basket
as frequently as every year. But there is research that suggests
that doing that within the context of the kind of measure we cur-
rently produce might itself introduce an upward bias in the index,
so it’s not quite so simple as it might appear.

Mr. SHAYS. Let’s hear from others as well, thank you.

Mr. GRAMLICH. Yes, in a way the notion of having the superlative
index that has automatically adjustable weights might be a very
sensible approach. If there were a procedure for automatically up-
dating the weights in line with changes in spending patterns, or
substitution, then the importance of going to surveys in shorter in-
tervals is reduced.

Mr. SHays. Anybody else want to respond to that?

Mr. Gorpon. There's a mention in the GAO statement of the fact
that all the other G-7 countries update their weights more fre-
quently than the United States has done so in the past. A typical
pattern is Japan, where they update the weights every 5 years, and
by January 1997, it already introduced 1995 weights.

Mr. SHAYS. You use a word that intuitively, I guess, what you're
saying is it’s not just what goes in the market basket, but how you
weight it within the market basket?

Mr. GRAMLICH. Yes, it’s what percentage is on home heating and
how much——

Mr. Suavys. I understand.

Mr. GRAMLICH [continuing]. Is on shelter. A minor issue is
whether you would want to use a single year’s weight on the most
recent year as opposed to the current practice which is to average
together 3 years, that is, 1993 to 1995. The only serious problem
I can see about using a single year would be that the weather
might be unusual and there might be an usually high or low
weight or expenditure on home heating fuel but [ think that could
be handled separately. So, I support the commission’s recommenda-
tion that there be a regular, annual updating of weights to the
most recent year or 2 years for which data are available.

Mr. SHAyS. Now, explain to me why there is a lag period in
terms of the data that goes into the formula? In other words, I
don’t quite understand why there’s such a lag?

Ms. ABRAHAM. It is a lag in getting the weights in that we're
talking about.

Mr. Suays. OK.

Ms. ABRAHAM. The updated weights. And the reason for that lag
is that, at present, the size of our consumer expenditure survey
sample, the survey we get the weighting information from——

Mr. Suays. But that consumer expenditure data is current?

Ms. ABRAHAM. No.

Mr. Suays. That’s a lag as well?

Ms. ABRAHAM. It’s collected quarterly but there is a lag in getting
it. We won't, for example, have all of the information that applies
to calendar year 1997 in our hands until sometime in the late sum-
mer or early fall. The last interviews aren’t done until March and
then, the Census Bureau processes the information and there is a
bit of a lag.


135

Mr. WILSON. One of the other points I'd like to make is when
we're talking about lower income families, there is a potential, I be-
lieve, that the substitution bias could indeed actually be larger for
those families. When the price of Red Delicious apples go up, they
may choose a different apple. When the price of —

Mr. SuHays. Just talk in your “mic,” a second, I’m sorry.

Mr. WILSON. I’m sorry. When the price of Red Delicious apples
6 up, they may choose different apples. When the price of ham-

arEer goes up, they may choose to have pasta.
r. SHAYS. Right.

Mr. WILSON. So you may end up with a degree of substitution
among those families and therefore, perhaps, a higher substitution
bias in the old CPI, a portion of which will be addressed by the
moving to the geometric mean at the lower-level substitution bias
but it still doesn’t address the upper-level substitution bias. That
bias occurs when families choose between or substitute between
hamburger and pasta for dinner. That’s something that the index,
I think Dr. Triplett was discussing.

Mr. SHays. We're not saying it in terms of income? You know,
I'm just qualifying that.

Mr. WILSON. Well, there is a possibility that those choices, per-
haps, don’t, aren’t made as often by higher income families.

Mr. SHays. I would think that they wouldn’t be. I would think
that income levels would determine your substitution rate.

Mr. WILSON. Yes.

Mr. Suays. Did you want to, Doctor?

Mr. TRIPLETT. Well, I just wanted to comment that this is a dif-
ficult area. There has been a lot of research on price indexes for
different kinds of groups, for income levels, for the elderly, as men-
tioned this morning. The difficulty—and none of the research, by
the way, seems to show that there are major differences in inflation
rates across demographic groups. They do tend to show that within
demographic groups, if you just apply the weights of the consumer
expenditure survey, for example, for people who are in low-income
groups, you find a lot of differences in indexes for people in the low-
income group and a lot of differences among the people in the high-
income group, but the average difference between the two groups
isn’t great.

Now the trouble with all that is, you’re using the price indexes
that the BLS collects. So Joe’s example is on the mark. If you're

foing to do a low-income price index, you wouldn’t & and price
fightincome goods. You’d price low-income goods. And if you were
doing, there was some question about pharmaceuticals this morn-
ing, if you’re doing an older person’s pharmaceutical index, older
people don’t buy the same pharmaceuticals as younger people. And
so you'd price the exact kind of pharmaceuticals that older people
buy rather than just taking a package across the spectrum. § the
difficulty with all this research is it only changes the weights and
applies the weights to the same price indexes that have been col-
lected across the board and it just turns out those exercises don’t
give you big differences in inflation. But they don’t really answer
the question because the question is you want to know, not only
the weights, but also what people buy, and how are those prices
moving.


13

January 1998, when a personal computer or selected item of
peripheral equipment, such as a modem, in the CPI sample
improves in some way, a regression-based quality adjustment
to its price will be made. The value of the improvement,
as derived from the regression estimates, will be deducted
from the observed price for the product. Conversely, if a
model deteriorates, the value of the difference will be
added to the price. Application of this method will
improve our measurement of price change for personal

computers and peripheral equipment.

Up to this point, I have focused principally on the changes
to the CPI introduced with the data for this past January.
Now, as your invitation to testify requests, I would like
to turn to the announcement we made earlier this month
concerning the use of the geometric mean formula in the
monthly CPI. We expect to incorporate this change into the
CPI for the month of January 1999, to be published next

February.

When I testified before the Subcommittee last year, I spent
a considerable amount of time discussing the issue of
substitution bias. At that time, I noted that BLS had

begun publication of an experimental index utilizing a


137

300 basis points for riskless investments. In other words, if the
short-term interest rate is 5.5 and the inflation rate is 2.5, the dif-
ference is 3.

Now, I don’t think that the financial markets are necessarily ac-
cepting of the view that there’s a bias in the CPI from locking at
those numbers because if you believe the original Greenspan and
the Boskin estimate, they would take that 2.5 percent inflation rate
down to maybe 1.25, and, yet, the markets are willing to trade
Treasury bills at 5.5. Well, that’s 4 or 5 percent, 400 basis points
of real spread. That would make those short-term instruments
very, very lucrative investments because there's no risk associated
with them. So I’m not so sure that the market is really, really quite
views the CPI bias issue the same way a lot of academic econo-
mists do.

Mr. Suays. How did you get into that by ——

Mr. Towns. No, but I thought it was very interesting information
that he gave us though, and it also points out that this is a very
complicated——

Mr. SHays. What triggered the question, I missed that question?
What was the, I heard the answer, what——

Mr. PopKIN. Impact on the economy.

Mr. Towns. Economy.

Mr. Suays. OK.

Mr. PopKIN. So, I’m really saying that I don’t think it’s going to
have much impact on the economy because I’m not so sure that the
markets accept the Boskin conclusion.

Mr. TRIPLETT. Yes, I think that people do tend to build some sort
of notions of accurate statistics into their decisions. It seems to me
that I heard an anecdote about a congressional committee, I’ve for-
gotten which one it was, it asked the Federal Reserve Board for
policymaking mistakes because the CPI was inaccurate and as I re-
member, this was not an official statement but there were some
unofficial statements by the staff, “well, look we already took it
into account, we haven’t made any mistakes.”

Mr. Suays. They discounted it.

Mr. TRIPLETT. And so I think, you did that, I see—

Mr. SuHays. No, we didn’t. You’re saying they discounted it al-
ready?

Mr. TRIPLETT. Well, they took it into account and so I think
that’s probably true of other decisionmakers in the markets as well.
The markets form some estimate of whether they think there’s a
CPI bias and take it into account and probably what we tell them
about it is something that’s information for them but it isn’t nec-
essarily going to move their decisions by the full amount of the
change in the CPI. So I’m supporting what Joel said about that.

Mr. PopkKIN. There’s one other, one other thing about the CPI
and the Fed I’d like to add, and that is, that whether or not the
CPI, as a measure of the rate of inflation is biased, what the Fed-
eral Reserve pays a lot of attention to is whether that rate is accel-
erating or decelerating, whether it’s speeding up or slowing down.
And no one has alleged that there’s any bias in the BLS measure-
ment of changes in the inflation rate, it’s the actual rate itself that
they question. Should it be two or should it be three? But whether


In an October 1997 report, we concluded that the CPI expenditure weights should be
updated more frequently than at the current rate of approximately every 10 years to make
the fixed market basket CPI more timely in its representation of consumer expenditures.”
‘The CPI is based on a fixed market basket of goods and services purchased by urban
consumers. These items are assigned weights by BLS to give proportionate emphasis for
price changes of one item in relation to other items in the CPI. The weights used to
aggregate the items into the overall index number for the CPI are based on the Consumer
Expenditure Survey, which BLS uses to determine what goods and services consumers
are buying. Historically, BLS has changed the expenditure weights only when making

major revisions to the CPI. Since 1940, that has occurred about every 10 years.

My comments on the need for and advantages of more frequent updating of the CPI
expenditure weights are based largely on our October report and will provide information
on (1) the views of individuals knowledgeable about the CPI on the issue of updating the
expenditure weights between major revisions to the CPI, (2) the updating practices of

other industrial countries, (3) the cost to update the expenditure weights, (4) the possible

sum ce Frequen
Is Needed (GAO/GGD/OCE-98-2, Oct. 9, 1997).
4


2

rice changes for various products, to make the index a more time-
ly indicator of consumer spending patterns. BLS recently revised
the decade old weights to reflect 1993-1995 spending. The Congres-
sional Budget Office projects a $16.5 billion Federal budget sav-
ings, over fiscal years 2004 and 2008, if the next adjustment of ex-
penditure weights is made in 5 years, rather than waiting 10 years
as BLS has done in the past.

The advisory committee to study the CPI, called the “Boskin
Commission,” concluded that the static CPI needs to be systemati-
cally transformed into a far more dynamic cost of living measure,
accounting for quality changes in goods, capturing the introduction
of new products and services, and reflecting current consumer pref-
erences. Without this broader approach to CPI reform, commission
members believe the cumulative cost of over-indexing the budget
over the next dozen years could exceed $1 trillion.

In response to calls for further CPI changes, BLS concedes the
value of more frequent updates to market basket expenditure
weights, sees the need to expand the breadth and timeliness of con-
sumer spending data, and hopes to find ways to include the effects
of new goods and new technologies on the cost of living. But the
Bureau’s plans to address these and other long range CPI issues
lack specifics, and appear tentative.

So we asked the BLS Commissioner, the Federal Reserve Board,
GAO, and other economic experts to describe an aggressive agenda
for CPI improvement, one that brings both sound research and ade-
quate resources to bear in building an inflation measure that keeps
pace with an accelerating economy.

We realize there is no perfect cost of living index. Just as we are
reminded each April, when Congress works to adopt a budget reso-
lution, that a chronically imperfect CPI exacts potentially immense
costs. The index will only remain relevant to the national economic
debate if Congress and the public are confident that the CPI is as
current, dynamic, and accurate as possible.

Again, we thank all our witnesses for being here today, and we
sincerely look forward to their testimony.

At this time, I would recognize Mr. Towns, the ranking member
of this subcommittee.

Mr. Towns. Thank you very much, Mr. Chairman. This is a very
serious matter. This is the second hearing that this subcommittee
has held to discuss changes in the economic measures which are
used in calculating the Consumer Price Index. Today, we will ex-
amine changes in the calculation of the CPI index made recently
by the Bureau of Labor Statistics as part of the modification it
makes to the index—every 10 years.

At the first hearing, held on April 30, 1997, we heard testimony
that improper economic assumptions used in the CPI resulted in
the necessary increase in Government spending, and an inappropri-
ate reduction in the amount of revenue Government could raise.
These conclusions were based on the 1996 findings of the Boskin
Commission. Although there is general agreement among the
economists that the CPI overestimates the presence of inflation,
many economists challenge the commission’s findings. In essence,
there is controversy, but no certainty, about the correct economic
measure.


72

explanation of the absence of such relationship, would add to the plan's credibility and

usefulness to CPI stakeholders.

Mr. Chairman, this concludes my prepared statement. I would be pleased to respond to

any questions that you or other Members of the Subcommittee may have.

al


27

available with a lag, so that the figures for 1997 are not expected to be available until the fall of
1998. Thus, the data from the Consumer Expenditure Survey can not be used to construct a “real
time” price index that fully captures consumers’ substitution among items. This lag is the reason
BLS's experimental superlative index is only produced with a delay. But, the important question
should not be whether it is possible to construct a perfect index, but rather whether techniques are
available for creating a monthly cost-of-living index that would represent an improvement over
the CPI as currently constructed.
‘The answer is yes. The Boskin Commission, which included my distinguished colleague

Robert Gordon, suggested as a possible solution the use of a “trailing Tomgvist” price index.
This index would use the Tornqvist index formula--which can capture substitution among items-
and would update weights each year. To be operational in real time, this index would need to use
lagged, or trailing, weights. For example, average weights from 1994-1995 could be used for
calculating 1997 changes in the cost of living. Another approach has been suggested by Matthew
Shapiro and David Wilcox. They have devised a so-called constant elasticity of substitution--or
CES--index that appears to largely eliminate upper-level substitution bias. In contrast to the
current setup that assumes no substitution among items, the class of CES indexes imposes a
positive degree of substitution among all items, and alternative CES indexes would impose
different degrees of substitutability. These authors searched to find the degree of substitutability
that provided the closest approximation to a benchmark “superlative” index, but which can be
implemented on a monthly basis in real time. There may well be other approaches worthy of

serious consideration to rectify the problem of upper-level substitution bias.



70

were identified in the recommendations and the performance goals and indicators. For
example, we made a linkage between the Boskin recommendation that said BLS should
move to a geometric means at the elementary aggregates level and the performance goal

and related indicators that mentioned geometric means.

BLS' performance goals and indicators that we linked did not always address the full
scope of the Boskin recommendations. For example, BLS has identified a series of
performance indicators for the performance goal “develop alternative measures of change
in living costs" that would result in published superlative indexes by fiscal year 2002,
which we linked to the third Boskin commission recommendation. We note that the
plan's discussion of this performance goal and its indicators does not address several
aspects of that Boskin recommendation, such as abandoning the current fixed market
basket CPI. In addition, this performance goal and related indicators indirectly relate to
the two overall Boskin commission recommendations for BLS to establish a cost-of-living
index as its objective and to develop and publish a monthly index and an annual index. If
the strategic plan provided more detailed information, it would help inform stakeholders
about the frequency (monthly and/or annually) with which the planned alternative index
measures will be published and would allow CPI stakeholders to make appropriate

linkages to the Boskin commission's recommendations.

We found no linkage between the performance goals and indicators and the eight

intermediate and longer-run recommendations of the Boskin commission. To determine

19


63

have prepared those plans as BLS has done at the direction of the Department of Labor.
Although the strategic and annual performance plans prepared by component agencies

such as BLS are not required to comply with the requirements of the Results Act, these

component agencies may use the statutory requirements as guidance in developing their
strategic and performance plans. In addition, the Department of Labor instructed BLS to
follow OMB's guidance to federal agencies for implementing the Results Act in preparing
its annual performance plan. Moreover, Labor included the entire BLS strategic plan as

part of the department's strategic plan.

BLS' strategic plan includes an agency strategic goal to "improve accuracy, efficiency, and
relevancy of our economic measures and program outputs through increased application
of state-of-the-art statistical techniques, economic concepts, technology, and management
processes.” The CPI is one of these economic measures, and one of the strategic plan's
objectives is to improve the quality of the CPI. The strategic plan provides performance
goals and performance indicators for this objective (see app. I for those for fiscal year

1999).

BLS’ fiscal year 1999 annual performance plan lists the same agency performance goals
and performance indicators for the CPI that are listed for fiscal year 1999 in BLS
strategic plan. Thus, the performance goals and indicators in the 1999 annual

performance plan are linked to those in the strategic plan.

12


20

Mr. SHAys. Thank you very much.

Dr. Gramlich,

Mr. GRAMLICH. Thank you, Mr. Chairman and members of the
subcommittee. I'd like to compliment you for holding these hear-
ings, for the role that you’ve played in promoting improvements in
the Consumer Price Index, and also I'd like to compliment BLS for
what they've done as Katharine Abraham has just said.

The hearings that this subcommittee held last year on the CPI
provided a clear summary of the arguments surrounding some of
the difficult measurement problems confronting the BLS.

Mr. Suays. I’m going to just have you tilt that. You can just tilt
it in front of you more. I want it to get your voice.

Mr. GRAMLICH. OK.

Mr. Suays. Is that all right?

Mr. GRAMLICH. Yes.

Mr. Suays. Can you still see your paper? Yes, that’s good.

Mr. GRAMLICH. A useful categorization of these issues divides
them into two parts. The first relates to the formula that is used
by BLS for building up the overall CPI from the individual pieces
collected by field representatives, and the second set of issues con-
cerns the individual prices themselves, and in particular how these
prices are adjusted to account for the quality change in the intro-
duction of new goods. Rather than to re-hash arguments surround-
ing difficult and controversial aspects of price measurement related
to new goods and quality change, a useful approach, we think,
might be to seek a common ground among the participants in this
discussion. This means pushing forward where there is some agree-
ment, or greater agreement, on the set of issues related to the ag-

regation formulas used to buildup the CPI, the first issue that I
described earlier.

As some have put it, we should go first after the low-hanging
fruit on the statistical tree. In that regard, the striking aspect of
hearings that you held last year was the virtual unanimity that a
price index that measures the cost of purchasing a fixed market
basket of goods and services, as the CPI now does, represents an
upper bound on the true changes in the cost of living. The reason
is that consumers respond to changes in relative prices by altering
the composition of their purchases, and this response lowers the
cost to them of the price changes.

There are two types of substitution bias. There’s a lower-level
bias, that the BLS is already dealing with, and upper-level bias re-
ferring to the present lack of substitution among 211 items in the
typical consumer's market basket. What I’m going to say from now
on refers only to the upper-level bias, because the lower-level bias
has been largely taken care of.

As the CPI is currently constructed, there’s no account for the
upper-level substitution possibilities available to consumers. Indi-
ces that do take account of such substitutions can be calculated,
economists refer to these as “superlative indices.”

Mr. Suays. Excuse me, doctor, I don’t usually interrupt but I'd
like you to just define “upper,” and “lower,” to the committee?

Mr. GRAMLICH. The upper-level is the substitution between the
211 categories, and the lower-level is within those categories. That
formula that you held up refers to substitution within those cat-


37

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 4

for one or more of five reasons. Critics claimed that (1) we did not give adequate credit for
the quality adjustments already performed by the BLS, (2) the kind of quality adjustments
we advocated could not be performed in "real time" by the BLS, (3) we did not take
adequate account of quality deterioration, (4) we extrapolated beyond existing research to
form estimates of quality-change bias for product categories where no research existed, and
(5) that we were elitists, identifying biases only in products consumed by the rich.

We have responded in detail to each of these criticisms and others. We have shown
that the extent of quality adjustment by the BLS is both minor, according to their own
calculations, and irrelevant, since our estimates were largely based on evidence independent
of BLS data. We recognize the difficulties of "real time" quality adjustment and for that
reason included as one of our core recommendations the establishment of a second
“research-based” CPI, to be published annually with a lag and subject to revision. As for
quality deterioration, we have found the examples to be few and to be outnumbered by
improvements which we did not take adequately into account, in part because they are
intangible and hard to measure. To those who question the subjective aspect of our quality
bias estimates and our extrapolations beyond existing research, we conceded that our bias
estimates may have been too high in particular cases but presented evidence that they were
too low in others.” Finally, far from being elitist, we pointed out that some of our largest
estimates of bias were for TV sets, owned by virtually every American household, VCRs,

owned by 80 percent of households, or more important, medical care which touches the life

2. See Gordon's comments on Moulton-Moses (1997), some of which are included in Boskin ef. al.
(1998).


57

We also obtained information on the updating practices in Japan, Italy, Germany, France,
Canada, and the United Kingdom, which along with the United States have made up the
Group of Seven (G-7) countries. All of them track consumer prices through a market
basket of goods and services and weight the prices of the items in the market basket.
According to information provided by BLS and contained in international publications, all
six update their consumer price indexes more often than the United States. Two updated
the weights of their consumer price indexes annually, and the other 4 did so
approximately every 5 years. However, BLS officials noted that the updates by the six
countries do not comprise the same level of detail as used for the CPI; for example, some

do not use consumer expenditure surveys as does the United States.

‘The estimated cost of updating the expenditure weights is relatively small in comparison
to the cost of major revisions. To estimate the cost for our October 1997 report, we
assumed that an update to the expenditure weights would have occurred in 1992 and
would occur in 2003, which is 5 years after major revisions to the CPI market basket. On

the basis of data supplied by BLS, the estimated cost to have updated the weights in 1992

“The G-7 countries have met to coordinate economic and monetary policy.

6


Introduction

Mr. Chairman and members of the Subcommittee, I am pleased to appear before you to
discuss improving the Consumer Price Index. I begin by thanking this Subcommittee for holding
today’s hearing and for its past work in examining the issue of bias in the CPI. Although these
issues are difficult and complex, your demonstrated interest has helped keep the focus on ways to
improve the index further.

‘The Consumer Price Index plays a central role in many aspects of private and public
decision making: The CPI is the key price measure for indexation of federal spending and tax
programs, and many contracts in the private sector are linked to the CPI. In addition, the CPI is
used for inflation adjusting the Treasury's indexed bonds, which help to provide a reading on
expectations of future inflation and on real interest rates. The CPI is also amorig the inflation
measures examined in the conduct of monetary policy. Thus, it is essential that the nation strive
for as accurate a measure as possible.

In that regard the Bureau of Labor Statistics has made laudable progress inthe past
several years. Sample rotation problems that were uncovered by BLS researchers have largely
been eliminated, The measurement in the categories of rent, computers, pharmaceuticals, and
health care services has been improved. Looking ahead, the recently announced decision to
apply the geometric-mean aggregation procedure should largely rectify so-called “lower-level”
substitution bias. The shift in emphasis from geography to product categories for sample rotation
provides an opportunity for BLS to ameliorate some of the bias associated with new goods,
provided that it actively rotates the sample for products undergoing rapid innovation. But while
these steps are impressive, the hard work must continue if the CPI is to keep up with an ever-

changing economy.


90

Ms. ABRAHAM. Put that way, I can’t disagree.

Mr. SANDERS. All right. And it should be studied. When you have
40 million people who are dependent, many of them lower-income
seniors. Now, my other question, having said that, Mr. Chairman,
I hope you will work with me to see if we can move in that direc-
tion, is what kind of political pressure is being put on you to drive
down the CPI? When you read in the papers every day that Mr.
Greenspan is talking the need to lower this, when you're talking
about people saying Social Security is going broke despite the fact
it’s going to pay out all of its payments for the next 33 years, do
you feel the pressure that you’re going to have to come in with re-
sults that are close to the Boskin Commission?

Ms. ABRAHAM. No.

Mr. Gorpon. I agree, there’s no reason for, that——

Mr. SHays. And I—if the gentleman will yield?

Mr. SANDERS. Yes.

Mr. Suays. Based on our hearings last year, I really felt com-
fortable that there wasn’t pressure on BLS and I felt that Dr.
Abraham was up to the task of resisting the pressure, frankly.

Mr. GRAMLICH. Could I comment on that?

Mr. SANDERS. Please.

Mr. GRAMLICH. I have the complete list of the chairman’s testi-
mony on this and the last one I have is January 30, 1997, and so
I don't think that he is talking a lot about this issue, at least re-
cently.

Mr. SANDERS. I would respectfully disagree. You may have a
statement that he made but would you disagree that Mr. Green-
span has on numerous occasions talked about his belief that the
CPI should be lowered?

Mr. GRaAMLICH. I think his statement is that the index ought to
be made as correct as possible, just what everybody up here is say-
ing. .

Mr. SANDERS. I think he has made, unless I’m very mistaken,
and I don’t think I am, I think he has made it very clear that he
expects, in making it correct, that it will be lower and that it can
save the Government substantia! sums of money.

Mr. Suays. If I could claim the committee’s time and just, we’re
going to go through another round here. I do want to say since I
characterized last year, I would also say that I think there was
consensus on the part of both Mr. Towns and myself that we need
to make sure you were being provided the resources to be more ag-
gressive in looking at some very legitimate issues that were being
raised about how we deal with substitution and so on. But we felt
that it needed to be done in the context of your agency, in your Bu-
reau, rather than in the context of Mr. Towns or I recommending
to Congress that we should just arbitrarily change the CPI, is that
alr’

Mr. GRAMLICH. Yes, that’s correct.

Mr. Suays. If I could—do you want to make one last comment?

Mr. SANDERS. Yes, just for the record let me quote New York
Times, May 3, 1997, second paragraph, “Some of the Nation’s most
powerful figures, including Alan Greenspan, Chairman of the Fed-
eral Reserve, had embraced the view that the index overstates in-


44

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 11

changes be in Boston versus Burbank? By eliminating much redundant data collection on
relatively straightforward and homogeneous goods, like apples and bananas, the BLS would
free up resources for a more concerted effort to introduce new products more promptly and
greatly expand the effort to price and assess the quality of more complex goods and services,
using scanner data where feasible.

How is Congress, the Administration, and the public to assess whether the BLS
responses and initiatives are adequate? Pollak (1998) makes a persuasive case that technical
and scientific issues be cordoned off from political issues like indexation, and that an
ongoing advisory body be constituted by an outside nongovernmental body like the National
Academy of Sciences, unlike the Boskin Commission which was a creation of the U. S.
Senate.

Pending creation of such a committee, there is an ongoing role for members of the
Boskin Commission to advise those who inquire, such as the current House subcommittee,
whether the activities and orientation of the BLS represent an appropriate and adequate
response to the Commission's report. The current agenda of BLS initiatives as reported by
A-G-M (1998) represents progress within the current, framework, bur reveals little
willingness to open up and reconstruct the framework itself (I would describe it as "nibbling
around the edges without taking a bite out of the core"). The Commission agrees with the
BLS thar "we do not believe it to be possible to produce a perfect cost-of-living measure.”
However, Commission members do not agree that the Congress nor the American people

should be satisfied with the failure thus far of the BLS to confront the core of the Boskin


85

Mr. Gorpon. It depends what medical plan they’re in.

Mr. SANDERS. Are you going to tell me here, in your judgment,
the prescription drug rates are not going up higher than general
inflation?

Mr. GORDON. That involves a question of what the consumer is
actually paying. The CPI concept of medical care prices, I believe,
is out of pocket expense by the consumer.

Mr. SANDERS. No. I am asking you——

Mr. Suays. Let me just interrupt the gentleman a second and
just say, the gentleman’s time, no, you're on, you get 10 minutes.

Mr. Towns. It’s your time.

Mr. SaNperS. Oh, I thought I was using his time, it’s not fair.
(Laughter.]

Mr. Suays. No, no your time had run out, sir, but given that you
are the ranking member, you can have as much as you want. Then
what we're going to do is we’re going to start the clock. He’s a
pussy cat so don’t be intimidated by him. The bottom line is that
the gentleman from Vermont has 5 minutes rolled over, another 5.

Mr. SANDERS. Thank you, Mr. Chairman. Mr. Chairman, I'd like
to submit for the record an article in the Washington Post by Dean
Baker who is an economist with Economic Policy Institute, Friday,
October 6, 1995, and I would like to quote from that for a start,
quote. He’s talking about the Boskin Commission.

While this commission was composed of distinguished economists, its conclusion
should be viewed skeptically. First, there was absolutely no effort to create a bal-
anced commission. ‘AL five members have previously testified that they believe the
CPI substantially overstated inflation. Economists who had given contrary testi-
mony to the committee, such as former Bureau of Labor Statistics commissioner,
Janet Norwood, were excluded.

So I, for one—end of quote—I, for one, take with a grain of salt
the conclusion of the Boskin Commission. I think we should not be
separating what’s going on, and I don’t mean to say you, Mr. Chair-
man, but this attack on the cost of living increase from everything
that’s going on in this Congress, cuts in Medicare, cuts in Medicaid,
cuts in programs for low-income people, tax breaks for the rich. I
think, Mr. Gramlich, you worked for Alan Greenspan, is that cor-
rect? Mr. Greenspan is the-——

[The information referred to follows:]


62

For this testimony, you asked us to review certain planning documents BLS prepared for
improving the accuracy of the CPI. The model for such planning documents is the
Government Performance and Results Act of 1993, also referred to as the Results Act.
The Act seeks to improve the efficiency, effectiveness, and accountability of federal
programs by establishing a system to set goals for programs based on their intended
purposes, measure the performance of those programs, and use performance information
to improve results. As you know, if successfully implemented, the Results Act will help
agencies focus on how to improve their programs’ performance in achieving desired

results.

‘The approach to performance-based management and accountability envisioned by the
Results Act is a dynamic and iterative process in which one stage builds on and
reinforces the progress made at earlier stages. Under the Results Act, agencies first were
to prepare long-term strategic plans that set the general direction for their efforts. The
strategic plans agencies prepared were to be the starting point for agencies to set

performance goals for programs in their annual performance plans.

‘The Results Act does not require component agencies of departments, such as BLS, to

prepare strategic and annual performance plans. However, some component agencies

AL


86

Washington Post

FRIDAY. OCTOBER 6, 1995,

Dean Baker

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Price Index"

I



121

D. MARK WILSON
Labor Economist,
‘The Heritage Foundation

Heritage Publications:

‘© California's Proposition 226: What ft Means for Union Members and Their Family Budgets, Heritage
Backgrounder, April 20, 1998.

‘© Increasing the Mandated Minimum Wage: Who Pays the Price?, Heritage Backgrounder, March 5,
1998.

‘© The Worker Paycheck Faimess Act: Ending the Involuntary Use of Union Dues, Heritage,
Backgrounder, February 12, 1998.

© Reforming Federal Job Training Programs: How Congress Can Avoid Previous Failures, Heritage
FLY, September 30, 1997

‘+ How The 1998 Budget Denies American Workers A Payroll Tax Break, Heritage F-Y.L, July 17,1997.

* Putting America Back To Work: Reforming The Employment Security System, Heritage
Backgrounder, June 10, 1997

‘* Flextime For Families: What Works For The Government Can Work For The Private Sector, Heritage
EYL, February 26, 1997.

‘* Senator Abraham’s Mandates Information Act: The Way To Help Congress Work Smarter, Heritage
FY L, February 6, 1997.

‘* Balancing America’s Budget: Ending the Era of Big Government. Labor sections in The Heritage
Foundations budget plan, 1997,

Feeling the Pinch: Why Income Gains Remain Elusive For Many American Families, Heritage F.Y 1,
October 7, 1996.

© High Layoffs and Long-term Unemployment Cloud Jobs Picture, Heritage F-Y.1., August 9, 1996,

How to Raise Take-Home Pay Without Destroying Jobs, Heritage F.Y.[., May 17, 1996.

Is There A “Clinton Crunch?”: How The 1993 Budget Plan Affected The Economy, Heritage

Backgrounder, May 1, 1996.

The Folly of Increasing the Minimum Wage, Heritage Backgrounder Update, April 22, 1996.

Wages, Profits and Income: Politic vs. Reality, Heritage F-Y.1., April 19,1996.

Labor, Employment and Wages Chapter in Heritage’s Issues 96, April 1996.

How to Close Down the Department of Labor, Heritage Backgrounder, October 19, 1995.

Saving Lives By Cutting Red Tape: Redefine The Federal Role In Workplace Safety And Health,

Heritage Backgrounder Update, Sept. 5, 1995.

‘* Welfare Reform and Job Training Programs: What Congress Doesn't Know Will Cost Taxpayers
Billions, August 16, 1995.

* Four Reasons Why Congress Should Repeal Davis-Bacon, Heritage Backgrounder Update, June 7,
1995.

Other published articles include numerous editorials that have appeared in the New York Times,
The Washington Times, and many newspapers.


124

Mr. Suays. Given that we just have two of us here, let me inter-
rupt you. I don’t understand the significance of it. What is the im-
pact of it being a quality change versus an increase in the cost?

Mr. PopkKIN. If you look to the catalytic converter as something
that no one would buy for their car——

Mr. Suays. Right.

Mr. PopkKIN [continuing]. Unless everybody else had to buy them.

Mr. Suays. I realize it added to the cost.

Mr. PopkKIN. It adds to the cost. The BLS asked the auto compa-
nies for the cost of making that catalytic converter and they'll sub-
tract it from the sticker price of the car when they start to price
it. That lowers the rate of inflation.

Mr. Suays. Right, because they consider it a quality change?

Mr. PopPKIN. Because they consider—which, in fact, the Boskin
Commission and the CBO have indicated and provided estimates
that, in fact, it should be treated as a price increase.

Mr. SHays. And that was your recommendation many years ago?

Mr. PopKIN. And that was my recommendation in 1971.

Mr. Suays. How will you deal with a seat belt?

Mr. PopkKIN. Seat belts I would treat as a quality change because
I benefit directly when I sit in my car and I strap on that belt. I
don’t benefit directly if I put a catalytic converter on my car and
nobody else does.

Mr. SHays. The argument would have been that in the long,
long, long run it was a quality change because health care costs go
down, and so on. That would be the argument? There was an argu-
ment on the other side with the catalytic converter?

Mr. PopKIN. Well, for the catalytic converter-—

Mr. SHays. You don’t have—

Mr. PopKIN. As I recall the argument on the other side came
from the people who put out the GDP because if you treat it that
way in measuring GDP, output should go up——.

Mr. Suays. Right.

Mr. PoPkKIN [continuing]. Because somebody had to work to make
that catalytic converter.

Mr. Suays. Right.

Mr. PopKIN. And you’d miss that, and that’s really what swung
the argument in 1971.

Mr. Suays. Jump in.

Mr. Towns. Yes, let me just say what about the new spark plugs
where you don’t have to have a tune up as often?

Mr. Popkin. Well, I mean, that would be a negative quality dete-
rioration. There are other things in cars that are quality improve-
ments. In fact, the BLS has calculated that as compared with 1969,
today’s auto is 70 percent better. I think that underscores how dif-
ficult, is it 70 percent better? Is it 50 percent better? Is it 90 per-
cent better? Does it fly instead of ride? Those are the kinds of ques-
tions, these are tough questions that you come into when you start
to evaluate quality change. So, I think on this issue there’s agree-
ment with the original BLS position that I took in 1971. The CBO
and the Boskin Commission Rave also agreed that environmentall:
imposed costs should be treated as a price increase and not a qual-
ity change, and I see no reason why the BLS doesn’t do that be-
cause they know what the number is that they have to plug in.


31

Mr. Suays. Thank you, Dr. Gramlich.

Dr. Gordon.

Mr. Gorpon. I’m very delighted to be here as a representative
of the five-member Boskin Commission which actually no longer
exists, having been disbanded more than a year ago after we made
our final report.

Mr. SuHaAys. Doctor, you have a wonderful, loud voice but I just
want you to lower the mic, just so, yes, thank you, that’s great.

Mr. Gorpon. It was now a little more than 3 years ago that this
process was kicked off by testimony by Alan Greenspan, and after
a round of testimony by a large number of academics, a little less
than 3 years ago, the Boskin Commission was established.

I have a written statement but I’m going to, what does the red
light mean?

Mr. Suays. No, it’s a mistake. Thank you. We're starting you
with green right now. It’s going to turn red once and we'll roll it
over and we'll stop you before it turns red a second time. It’s 5 min-
utes, it gives you a sense.

Mr. Gorpon. I have a prepared statement, and I’m not going to
have time, obviously, to go through the whole thing, and I’m going
to skip over the initial debate about the Boskin Commission rec-
ommendations and some of our responses to the critics because I
think what you’re more interested in is what we think of what the
BLS has been doing since the commission’s report was issued.

I wanted to emphasize that throughout the whole process the re-
lations between the commission members and the BLS have been
most cordial and constructive, much of the research that we cite in
forming our estimates was originally performed at the BLS. And
BLS officials were open in their recognition, as they still are, that
there are many problems with the CPI of various levels of dif-
ficulty. One of our main recommendations, as we've already had
pointed out, that is the movement to geometric mean has now been
accepted and announced a couple of weeks ago by the BLS for im-
plementation next year. And I think the commission members are
fully supportive of their decision to apply that only to 60 percent
of the CPI and we understand their reasons why they would not
want to apply geometric mean to the whole 100 percent.

Quality adjustment is very difficult and one of the reasons, in de-
fending our estimates, that we think the number we came up with
is roughly right, despite some claims that a few of our category es-
timates of quality change were overstated, is there are a large
number of improvements that are hard to quantify. For that rea-
son, I think, we agree with the BLS that we may never get a per-
fect CPI but I wanted to point out that the current issue of Con-
sumer’s Reports, May 1998, contains a lot of advice to consumers
about when to repair existing consumer items and when to throw
them out. And along the way they have a whole list of the kinds
of quality improvements that we did not take into account. For in-
stance, a new refrigerator will consume at least $250 less in power
over its lifetime than older units. New dishwashers are much quiet-
er and more frugal with power and water. New washing machines
are markedly more energy efficient than old ones. A new TV set,
in almost any size, will offer more than the one it’s replacing. New
CD players hold more discs than older ones. New gasoline


7

The committee will hear from the first four people I have men-
tioned, but all are invited to respond to questions, and comment on
what you have heard from the members, as well as what you’ve
heard from other participants in this hearing.

And, Dr. Abraham, we learned a lot from our last hearing a year
ago, or nearly a year ago, and thank you for being here. And your
intuition is right, if you'd also lower the mic. You’re going to need
to bring it a little closer. Thank you, we’ll see how you sound.

STATEMENTS OF KATHARINE ABRAHAM, COMMISSIONER, BU-
REAU OF LABOR STATISTICS, U.S. DEPARTMENT OF LABOR;
EDWARD M. GRAMLICH, GOVERNOR, BOARD OF GOV-
ERNORS, FEDERAL RESERVE SYSTEM; ROBERT J. GORDON,
THE ADVISORY COMMISSION TO STUDY THE CPI, NORTH-
WESTERN UNIVERSITY; AND BERNARD UNGAR, DIRECTOR,
GOVERNMENT BUSINESS OPERATION ISSUES, U.S. GENERAL
ACCOUNTING OFFICE, ACCOMPANIED BY LAUREN YAGER,
ACTING CHIEF ECONOMIST; AND KATHLEEN SCHOLL, SEN-
IOR ECONOMIST

Ms. ABRAHAM. We'll try that.

Mr. SHAys. Yes, you’re going to have to still project. You're going
to still have to project a bit. We'll let you know. Why don’t you
start and we'll see how you come across.

Ms. ABRAHAM. OK, thank you, Mr. Chairman. I do have a writ-
ten statement that I’d like to have included in the record.

When I appeared before the subcommittee at the hearing last
year, I talked about BLS’ efforts over the years to improve the Con-
sumer Price Index. This morning I'd like, if I could, to take a few
minutes to talk about steps we’ve taken since that last hearing,
and also the further steps that we have planned, to address the
issues that have been raised concerning the CPI. And I'll try to
speak in English, not formulas. [Laughter.]

There are, from my perspective, three broad issues that have
been raised with respect to the CPI. First, the currency of the mar-
ket basket used for—that underlies the index. Second, the whole
issue of consumer substitution in response to relative price change.
And, third, the treatment of new product introductions and of
change in the quality of currently priced goods and services. I’d like
to talk very briefly about what we’ve done and have planned to do
to address each of those issues.

First then, the issue of the currency of the spending pattern that
underlies the index. We have, as you already noted, introduced, ef-
fective with the data for January, an updated market basket that
rests on consumer spending patterns over the 1993 to 1995 period.
Second, we have requested funding, and I’m optimistic that we'll
receive funding, to expand the size of our consumer expenditure
survey, and also to develop computer systems that will allow us to
introduce updated market baskets in the future that are more cur-
rent as of the time they are introduced than was the one that we
just introduced. As of January, when we put our new market bas-

et in place, it was 3.5 years out of date; it had if you will, that
much of an average lag. With the things we have planned, the next
time we introduce a new market basket, there will be a lag of only
2 years. So I think that will be an important improvement. And,


139

but you were well worth waiting for. It was very interesting and
we thank you very much. It helped clarify some points and I’m
happy you participated. Thank you.

We'll close this hearing.

(Whereupon, at 2:07 p.m., the subcommittee adjourned subject to
the call of the Chair.]

ie)


46

REFERENCES

References to the research used in the Boskin Commission Report and to the
subsequent debate begins with the Table of Contents of the symposium on this issue
contained in the Winter, 1998, issue of the Journal of Economic Perspectives. The

subsequent pages contain references from the paper by Boskin et. al. in that issue.

Pe feel of .
Economic Perspectives

Contents Volume 12 + Number 1» Winter 1998

‘Symposia
(Measuring the CPI
Michael J. Boskin, Ellen R. Dulberger, Robert j. Gordon, Zvi Griliches, and
Dale W. Jorgenson, “Consumer Prices, the Consumer Price Index,
and the Cost of Living” ......2...0..ce.-ccseees
Katharine G. Abraham, John S. Greenlees, and Brent R Mouiton,
to Improve the Consumer Price Index” ..........
‘Angus Deaton, “Getting Prices Right: What Should Be Done?"
W. Erwin Diewert, “Index Number Issues in the Consumer Price Index”
William D. Nordhaus, “Quality Change in Price Indexes”
Robert A. Pollak, “The Consumer Price Index: A Research Agenda and
‘Three Proposals” .



6

vivors. And, as you all know, the CPI index is used to determine
poverty guidelines. And those guidelines affect the services going to
some 38 million people, and many other programs, as you know,
are impacted in a similar manner.

Now I cite the human dimension of the CPI to set the social and
economic context for what I hope will be our discussions. Because
when the debate turns to the possibility of lowering the CPI, we
have to remember that we're talking about the lives and health of
millions of Americans, young and old. They cannot be with us
today literally, but they’re sure represented here and no one should
forget that for a moment.

So thank you, Mr. Chairman, members of the committee.

Mr. Suays. I thank the gentleman.

Before swearing in the witnesses, I’ll just take care of two items
of business. I ask unanimous consent that all members of the sub-
committee be permitted to place an opening statement in the
record, and that the record remain open for 3 days for that purpose
and, without objection, so ordered. I ask further unanimous consent
that all witnesses be permitted to include their written statement
in the record and, without objection, so ordered.

And I would just make another point before—well, let me first
swear in the witnesses. And I’d ask them all to rise. Anyone else
who you think might help you respond to a question that is accom-
panying you, I’d like them to rise as well. And if we call them, we'll
have them identify themselves for the record.

{Witnesses sworn.]}

Mr. Suays. I would just like to say before announcing our wit-
nesses that there is no hidden agenda at this hearing. No. 1, I
would make that point. And, second, that I think the interest of all
the subcommittee members is to have the most accurate account,
notwithstanding Mr. Sanders’ comment. Whether it goes up or
down, whichever way it takes us, if it’s the most accurate, that’s,
I think, the preference of the committee. And I will say also that
we were intending to have three hearings, and my staff director
wasn’t eager to have that. And so what he did was show me the
formula for capturing substitution, the old arithmetic mean for-
mula, and then the geometric mean formula and he showed this to
me and said, “Do you really want three hearings?” And I said, “No,
one will do fine.” [Laughter.]

So, we have with us Dr. Katharine Abram, Abraham, excuse me,
Commissioner, Bureau of Labor Statistics, and would like to thank
her for her willingness to appear with other panelists, and not do
what some Government officials like to do and ask to be all by
themselves, because the exchange will be helpful and it will be a
fair and open exchange and so, Dr. Abraham, I appreciate that.
Second, we have Dr. Edward Gramlich, member oF the Board of
Governors, the Federal Reserve System, and welcome him as well.
And then Dr. Robert Gordon, the advisory commission to study the
CPI, known as the Boskin Commission, and he’s from Northwest-
ern University. We appreciate his being here. And Bernard Ungar,
Director, Government Business Operations Issues, the U.S. Gen-
eral Accounting Office [GAO]. And he’s accompanied by Lauren
Yager, chief economist, acting; and Dr. Kathleen Scholl, who is the
senior economist.


40

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 7

1998,
In addition to the first problem involving new products — the late delay of these
products into the CPI after much of the price decline has already taken place — the second
and potentially more important problem is that the very invention of a new product creates
value. Consumers like stereo better than mono sound, they like color better than black and
white TV, they like the option of viewing recent movies at home without the expense of
babysitters, they like the convenience of microwave ovens, and they surely appreciate the
increasing availability of new diagnostic medical tests, non-invasive laser surgery, shorter
stays at hospitals, less pain from a variety of procedures, and the four years of increased
longevity that medical science has made possible over the past two decades. None of these
benefits of modern life is included in our overall bias estimate of 1.1 percent per year.
Our omission of the value of new products is the main reason that I believe our 1.1
percent overall estimate is too low. But there is other evidence as well. In the past three
years an alternative measure of consumer price inflation, the personal consumption deflator
of the Department of Commerce, has increased at a rate about 0.5 percent slower than that
of the CPI. It uses more up-to-date weights and alternative measures for the prices of
computers, airline fares, and medical care. But otherwise it is based on the individual
components of the CPI and incorporates about two-thirds of the bias in the CPI. By this
alternative piece of evidence, the CPI could be biased upward by the 0.5 difference with the

PCE, plus another 0.75 points of the 1.1 point bias we compute, for a toral of 1.25 percent


120

D. MARK WILSON
Labor Economist
‘The Heritage Foundation

Since February 1995, Mr. Wilson has been the Labor Economist at The Heritage
Foundation.

Mr. Wilson specializes in workplace policy issues, examines the impact of labor market.
mandates and regulations, and the role of government in labor-management relations. His most
recent work involves the minimum wage, reforming the Employment Security System, analysis of
the ineffectiveness of federal job training programs, flex-time for private sector workers, and the
impact of private sector mandates on wages and job opportunities.

Other Recent Issues Include:

© The 21*workplace, wage growth and income inequality, union activities and workplace
democracy, Labor Department appropriations, and OSHA Reform.
‘+ Development of The Labor Home Page: Workplace Issues Online at:
http://www heritage.org/heritage/labor/

For 13 years, until February 1995, Mr. Wilson was a senior economist in the U.S.
Department of Labor, Office of the Assistant Secretary for Policy, providing analysis to the
Assistant Secretary, the Chief Economist, the Secretary of Labor, and the White House on a wide
variety of labor market issues. His work included:

Economic Impact Analysis Workgroup of the President Clinton's Health Care Task Force.
Drafted the analysis of the impact of the proposed mandated health insurance on
employment. For this work Mr. Wilson received the Secretary’s Exceptional Achievement
Award in 1994,

© Labor Force analysis of the impact of the 1989 minimum wage legislation for Secretary Dole,
and President Bush's White House Domestic Policy Council.

* Economic analysis on the current condition of the U.S. economy, labor and macroeconomic
trends and forecasts.

Education:
Mr. Wilson received a B.A. in economics trom Kent State University in December 1979,

and continued with masters degree studies at George Washington University from 1983 to 1987 in
macroeconomics, microeconomics, econometrics, and labor market theory.


19

ATTACHMENT A: Components Retaining the Arithmetic Mean

(Laspeyres) Formula

1.Selected shelter services:

A) Rent of primary B) Owners’ equivalent c)
residence rent of primary
residence

2.Selected utilities and government charge:

A) Electricity C) Residential water and E),

sewerage maintenance

B) Utility natural gas D) State and local F
service registration, license,
and motor vehicle
property tax

3.Selected medical care services:

A) Physicians’ services C) Eyeglasses and eye E)
care
B) Dental services D) Services by other F)

medical professionals

Housing at school,
excluding board

Telephone services,
local charges

Cable television

Hospital services

Nursing homes and
adult daycare


4

formula which allowed for some degree of consumer reaction
to change in the relative prices of the goods and services
being purchased. Prior to my arrival at the BLS in 1993,
CPI staff had raised the possibility of adopting a
geometric mean formula in some or all index components,
possibly in conjunction with the CPI Revision then being
launched. By 1996, the issue had become a key element of
the report of the Senate Finance Committee’s Advisory
Commission to Study the CPI. In April of last year, we
reported that we would conclude our review of the issue and
announce our decisions by the end of 1997, and that we
would incorporate whatever changes we believed prudent in

the CPI to be published for the month of January 1999.

As I indicated in my March 31 letter to you, and as we also
indicated in making our announcement the week before last,
we found the evidence relevant to assessing the use of the
geometric mean to be much sparser than we had expected.
Taken in its entirety, however, the evidence unambiguously
supports the proposition that consumers can, and do, alter
their purchasing behavior in response to changes in the
array of prices that they confront in the market place.
Because the geometric mean estimator can better reflect the

effects of such changes in consumer spending than can the


3

For those of us in Congress, the CPI has a different meaning.
The budget implications of a change in the CPI could mean that
major program changes could be achieved without an overt change
in policy. A change in the CPI that is calculated, would directly
alter the baseline projections of a change in indexing provisions
that would represent a policy change as well as a cut in outlays.
The Congressional Budget Office estimated that 5 years after an
adjustment reducing the CPI by half a percentage point per year,
the annual deficit would be reduced by over $25 billion. Forty per-
cent of these savings would come from tax increases. The remain-
ing 60 percent would come from decreases in the rate of growth
and expenditures for entitlement programs.

Therefore, this kind of change in the CPI could affect almost 70
million persons, including 43.1 million Social Security beneficiaries,
about 22.6 million food stamp recipients, about 3.9 million military
and Federal Civil Service retirees, and their survivors, and 24.2
million children who eat subsidized meals in the school lunch pro-
gram. Also, nongovernmental expenditure changes in the CPI
would affect about 2.8 million workers who are paid according to
collective bargaining agreements that are tied to the index. Fur-
ther, let me point out, it could mean higher taxes for all Americans
because the CPI is used to calculate the standard deduction used
in determining your income tax bill.

Mr. Chairman, I know that the budget implications of a small
percentage change in the CPI can offer a tempting solution to some
difficult problems. However, let me caution. We must not forget
about the elderly who rely on Social Security and Medicare, and
those struggling Americans who rely on the Earned Income Tax
Credit, food stamps, and Medicaid. Each of these programs would
be adversely affected by a slight change in the CPI. It may be only
half a percentage point to you, and to me, and to my colleagues of
this committee, but to them it could be the difference between shel-
ter or no shelter. It could be the difference between food or no food.
It could be the difference between sick and well.

So, Mr. Chairman, before we advocate these kind of changes, let’s
be absolutely sure that we’re making the best economic decisions
for all Americans.

Thank you for holding this hearing. I look forward to the testi-
mony coming from the witnesses because, as I indicated, this is a
very, very serious issue.

TL yield back.

ir, SHAys. I thank the gentleman for his fine statement, and
would now call on Mr. Sanders from Vermont.

Mr. SANDERS. Thank you, Mr. Chairman, and thank you for hold-
ing this important hearing, and thank you for holding the last
hearing we had to discuss this issue.

This is, as I think Mr. Towns just indicated, an issue of enor-
mous consequence and the repercussions of it will be felt by tens
and tens of millions of Americans, old people, workers, veterans,
and many others. So this is big stuff, and before we go forward we
should do a whole lot of thinking about it.

Now, I must tell you up front, Mr. Chairman, that I get very
angry at people who see the cut, the possible cut in CPI as a back
door effort to save the Government money. I think Mr. Towns just


132

‘These are some of the areas where the Commission is most worried that quality change is
understated or new goods are not promptly introduced. It is conceivable, even likely, that many
quality improvements are in items and varieties that are beyond the reach of median-income
households. Thus, while the CPI may overstate inflation in the market basket for high-income
consumers, it may understate inflation for low-income households. The BLS needs to examine the
whole issue of whether the impact of quality change and new items is different on households in
different percentiles of the income distribution. The issue of whether the CPI is to be weighted
correctly, in my view, by averaging households’ spending proportions or by preserving the current
system, must be addressed before further work can go forward on quality change and new
products. How to treat those two issues can only be intelligently informed when the index family

and weighting are decided.

Most observers agree that a cost-of-living index, if it were developed in practice, would be
the appropriate measure to index entitlements and certain aspects of the tax code. I have tried to
emphasize that substitution, quality change, and new products are not the only issues separating
the CPI from a COLI. Two mentioned so far in this testimony are the index family and
representing it properly and the taking account of the impact of environmental costs on consumers.
Crime, congestion, infrastructure, income and other taxes, and government services are others.
Some of these, such as the environment and crime, are principally quality-of-life issues, but they
often prompt consumers to spend income to prevent an erosion in their level of well-being. Taxes
paid directly and indirectly by consumers and the quantity and quality of the government services

they receive in return also affect their cost of living.


110

The Consumer Expenditure Survey

‘The Consumer Expenditure Survey provides weights for the CPI. At present, itis too small
(approximately 5000 "consumer units" or households) to obtain CPI weights from one year’s
data, so three years’ data (1993-95) are used to determine the weights. This three-year averaging
process necessarily delays the availability of CPI weights and retards their introduction into the
index.

BLS proposes to increase the size of the Consumer Expenditure Survey from its present
= yroximately 5000 consumer units to approximately 7500 units. The intention, as I understand

lity or accuracy in CPI weights. The change is in the right direction, and deserves
support. But the survey ought to be larger than 7500 households, because it ought to be large
enough to permit CPI weights to be calculated from a single year’s expenditure data.

The ideal for a Laspeyres index would have the 1998 CPI weighted by consumer expenditure for
1997. That may not be practical, because of processing time for the expenditure survey data and
the time required for analyzing the expenditure data before CPI weights can be estimated. But if
the Consumer Expenditure Survey were expanded so it became large enough to use a single
year’s survey data for CPI weights, it ought to be possible to cut a year and possibly more from
the present lag between the weighting period and the date at which new weights are introduced
into the index. It would also then be possible to re-weight the CPI annually, which would keep
the weights current and minimize upper level substitution bias.

Expansion of the Consumer Expenditure Survey ought also to aim for increased accuracy of the
CPI weights (not just maintaining the present accuracy). In a paper published in the St. Louis
Federal Reserve Bank Review, I pointed out, as have others, that the Consumer Expenditure
Survey does not give compatible results~either in levels or in trends-to the Personal
Consumption Expenditures component of the national accounts. This is true for major
consumption components like motor vehicle purchases and food at home. When the two data
sources on consumption expenditures disagree, that does not necessarily imply that the national
accounts consumption data are always right and the Consumer Expenditure Survey information is
always wrong. Nevertheless, it does raise questions about the accuracy of CPI weights. Analy'sts
of consumption data, including policy analysts in the Executive branch and in Congressional
agencies, have long felt that the Consumer Expenditure Survey data need attention. A
conference involving BLS staff and users of Consumer Expenditure Survey data will take place
in May. A comprehensive review of the Consumer Expenditure Survey data and methodology
deserves high priority, and the review should consider both CPI weighting uses of the survey am!
the other uses for consumer expenditure data, particularly research and policy analysis uses.

The Boskin Commission did not emphasize the accuracy of Consumer Expenditure Survey data
in its review of the CPI, or propose additional expansion of the survey. It is hard to understand
how the CPI can be accurate without accurate weights. And the U.S. Consumer Expenditure


69

alti i on

Z d Indicators

As you requested, we also compared the extent to which certain BLS performance goals
and performance indicators contained in its strategic plan that relate to improving the CPI

reflected the recommendations made in December 1996 by the Boskin commission.

Overall, we found linkages between BLS' performance goals and indicators relating to
improving the CPI and three Boskin commission recommendations (see app. II). The
commission referred to these specific recommendations as short-run recommendations~
that is, those that the commission thought could be implemented immediately, with little
additional resources or no data collection initiatives.” These recommendations were to
develop a monthly index that would adopt a superlative index formula at the upper level
of aggregation in the index, to be called the CPI, and replace the current fixed market
basket CPI;* use a geometric means formula at the lower level of aggregation in the CPI?

and expand the use of regression techniques. We based the linkages on concepts that

"The Boskin commission placed its recommendations to BLS into three categories: short
Tun, intermediate run, and longer run. We placed two unclassified recommendations into
a generaV/overall category.

*The Boskin commission referred in its recommendation to a particular form of
superlative index but BLS does not agree that the form referred to should be
characterized as a superlative index.

*On April 16, 1998, BLS announced that, beginning in January 1999, it will use a geometric
mean formula to aggregate the lower-level categories for approximately 61 percent of
total consumer spending represented in the CPI.

18


24

The hearings that this Subcommittee held last year on the CPI provided a very clear
summary of the arguments surrounding some of the difficult measurement problems confronting
the BLS and the range of professional opinions conceming the quantitative significance of those
problems. A useful categorization divides these issues into two parts. The first relates to the
formula used by BLS for building up the overall CPI from the individual prices collected by field
representatives. Although these issues are quite technical, they are fairly well understood by the
BLS and by economists outside the statistical agencies. The second set of issues concems the
individual prices themselves, and in particular, how these prices are adjusted to account for
quality change and for the introduction of new goods, These issues are extremely difficult--both
conceptually and practically~and there is much less consensus about the quantitative
significance of the bias associated with new goods and quality change. Research into all of these
questions has continued over the past year, but, to my knowledge, there have been few major

developments that would alter significantly the opinions voiced by the witnesses at last April's

hearing.
Improving the CPI

Rather than rehash arguments surrounding the difficult and controversial aspects of price
measurement related to new goods and quality change, a more useful approach might be to seek
common ground among the participants in this discussion. This means pushing forward where
there is greater agreement on the set of issues related to the aggregation formulas used to build
up the CPI. As some have put it, we should first go after the “low-hanging fruit” on our
statistical trees. In that regard, a striking aspect of the hearings that the Subcommittee held last
year was the virtual unanimity that a price index that tracks the cost of purchasing a fixed market

2


10

Testimony of
KATHARINE G. ABRAHAM
COMMISSIONER OF LABOR STATISTICS
before the

SUBCOMMITTEE ON HUMAN RESOURCES
HOUSE COMMITTEE ON GOVERNMENT REFORM AND OVERSIGHT

APRIL 29, 1998

I very much appreciate the opportunity to appear once again
before the Subcommittee to discuss the Consumer Price Index
(CPI). As I indicated in my testimony a year ago, the
Bureau of Labor Statistics (BLS) has a long tradition of
being in the forefront of price measurement research and
operational innovation. In that testimony, I chronicled a
lengthy list of CPI improvements introduced by the BLS over
the years, emphasizing especially important improvements
introduced in 1995, 1996 and the first part of 1997. My
understanding is that the Subcommittee wishes to review
both the further changes we have made since last year and
our plans for future improvements. I am proud of the
progress we have made, and welcome this opportunity to

review our accomplishments and discuss our future plans.


29

with this problem, the Boskin Commission suggested pursuing a two-track approach. For the
first track, BLS could publish a monthly index in real time that would never be revised. This
index would be much like the current CPI except that--going forward--it could be based on an
aggregation formula that minimizes upper-level substitution bias. For the second track, BLS
could publish, with a lag, a superlative index that incorporated full information on changing
expenditure shares and could be revised subsequently to incorporate other improvements to the
CPI as well.

This two-track approach has advantages and disadvantages. On the positive side, the two
track approach would provide indexes for users with diverse needs: a never-revised index for
those for whom revisions would impose operational difficulties and a second index that would be
the best possible measure of changes in the cost of living. On the negative side, I am concerned
that the publication of two different price indexes as part of the CPI program might generate
some confusion. If this confusion were judged to be a serious problem, BLS could alternatively
produce a single measure that was revised and, ultimately, incorporated all information on

spending patterns in the best possible way. For example, the CPI for April could be i

ly
constructed using one of the approximations to a superlative index that I described above, but
when full data on consumer expenditure shares became available some months later, the level of
the CPI for April could be revised to be an exact superlative index rather than a close
approximation. Were this to be done, government and private contracts that used the CPI for
indexation would have to switch over to a level adjustment, using only the final CPI for April to
set April's payments. The importance and feasibility of these switches could also be addressed by

the BLS study.


98

Mr. Gorpon. And I might add that the BLS is already on to
that, and before the Boskin Commission was established, they did
the research on it and they are—they have now announced their
intention to fix it. So that’s the lowest hanging. So the next step
would be an announcement by the BLS of a specific plan to intro-
duce more frequent updating of the upper-level weights. That’s one
of our major recommendations.

Mr. SHays. And that’s the transfer from one category to—the
substitution from one category to the other.

Mr. Gorpon. And the fact that——

Mr. Suays. Give me an example of that just so we give——

Mr. GorDOoN. Well, the most obvious is that in the whole area of
TV, video, and personal computers, until this year, they were using
1983 to 1985 weights when the consumers weren’t buying personal
computers.

Mr. Suays. Yes.

Mr. Gorpon. So that particular source of price decline and we
all know how dramatic that has been was just left out of the index
entirely. So more frequent updating tends to bring in more rapidly
and with a larger weight the most modern products which often
tend to experience price declines instead of price increases and for
that reason the upper-level weights are important in the overall
bias that turns out.

As I mentioned in my remarks, outlet substitution bias is a
tough problem because you have to figure out what fraction of the
difference between a discount store and a full-service store rep-
resents service, represents something the consumer wants. And
we've had debates back and forth on that. I think that’s not some-
thing that BLS should be prepared to do right now. They should
be thinking about research initiatives that would help inform ev-
eryone on that question.

And then, finally, on the quality change, as I said, we need a sec-
ond research-based index. And it’s too big a task for the BLS. I
think they should do it in collaboration with private agencies in the
economy whose business it is to measure quality over time.

Mr. SHays. And Dr. Yager, excuse me, Dr. Ungar, Mr. Ungar,
I’m sorry, you know who | mean.

Mr. Uncar. Yes. [Laughter.]

Mr. SHays. Mr. Ungar, in your statement to the committee, and
Dr. Scholl and Dr. Yager, I’m sure, participated in your statement,
you talk about what BLS has not done in terms of the Boskin Com-
mission. Now, the gentleman from Vermont may be just as happy
that they totally ignore the report. {Laughter.]

But I want to make an assumption that there are some impor-
tant elements there that should be dealt with and then I would
like, Dr. Abraham, for you to tell me why it’s not in your, and have
you, you’ve looked at their report and you're aware, so, just pick
one of the—there were 13 recommendations?

Mr. Uncar. Yes, 13 to BLS, that’s correct.

Mr. Suays. Right, and to BLS, I'm sorry, or 12, were there 12?

Mr. Uncar. Well, there were 12 in the original Boskin Commis-
sion report.

Mr. Suays. Right.


91

flation by more than a percentage point.” Would you like to com-
ment on that Dr. Gramlich?

Mr. GRAMLICH. Sure, that was based on analysis of the index. I
mean, just the same kind of thing the Boskin Commission did. It
didn’t reflect any ideas about cutting the budget, it just reflected
a statement that this is how he, what he and staff at the Federal
Reserve felt the bias was.

Mr. SANDERS. In other words, all that I’m saying, that’s what I
said. That he has been public in saying that he thought that the
CPI was too high and that it should, and that he thought it was
too high, and that it should eventually be cut.

_Mr. GRAMLICH. In perfect agreement with the Boskin Commis-
sion——

Mr. SANDERS. Yes.

Mr. GRAMLICH [continuing]. That had studied this, and is not
really dissented from by the BLS.

Mr. SHays. Would the gentleman mind me just asking Dr. Abra-

m—

Ms. ABRAHAM. No, just on that point, I do want to be clear that
this 1.1 percent, or 1 percent, or whatever, is not a figure that the
Bureau of Labor Statistics has endorsed. I personally am skeptical,
I have to say, of any quantitative estimate of bias in the CPI,
mainly because the evidence in so many of the areas is, in my opin-
ion, sketchy. So we sort of agreed to disagree on that. But what we
are trying to do is work in every way we can to make technical im-
provements in the measure, whether those raise the measure or
lower the measure. And I feel that’s been respected and understood
and we've been left alone to do that.

Mr. SANDERS. Can I get 14 seconds?

Mr. SHays. You can, and then I’m going to make a comment and
give it to Mr. Kucinich.

Mr. SANDERS. OK. Dr. Abraham, would you comment on what
Dean Baker said that “all five members of the Boskin Commission
have previously testified that they believe the CPI substantially
overstated inflation?” In other words, was that a balanced commis-
sion or was that already a stacked deck?

Ms. ABRAHAM. Well, I think you would have to say that every
one of the people on the Boskin Commission was a well-respected,
if not, distinguished economist. So I’m certainly not going to criti-
cize——

Mr. SANDERS. Not a problem——

Ms. ABRAHAM [continuing]. The Boskin group on the basis of
their credentials.

Mr. SANDERS. Thank you.

Mr. Suays. And for the record, I would make an assumption, but
I guess I want to ask. Dr. Greenspan wouldn’t be calling you up
and asking you to lower the—[laughter]—and I mean this seri-
ously, would not be asking you to change the index either up or
down. Is that a correct assumption?

Ms. ABRAHAM. Yes.

Mr. SuHays. But this is an important issue and we're going to
pursue it. I mean the whole concept. And I’m really happy that the
members are patient. Yes, sir, and then?


ll

As the Subcommittee’s invitation of April 17 notes, the BLS
introduced a number of very important changes in the CPI
effective with the data for January 1998, released two
months ago on February 24. To be more precise, the CPI now
is based on consumer spending patterns for the 1993 through
1995 time period, a new sample of geographic areas that
better represents the current distribution of the U.S.
population, and a new classification structure that better
reflects the categories of goods and services consumers
buy. These important changes represent the attainment of
some of the more critical objectives of the large-scale
effort to revise the CPI for which funds were first
received in Fiscal Year 1995. Although major components of
the CPI Revision project continue through Fiscal Year 2000,
the changes introduced in February complete the expenditure
weight and geographic area sample updating that also have

been core components of every prior CPI Revision.

Although the updated market basket introduced in January is
considerably more current than that it replaces, it still
was 3% years old as of its introduction date. Our proposed
CPI improvement initiative, which I will discuss in a few

moments, will allow us to introduce future expenditure


97

Mr. Suays. I’m beginning to, thank you, gentlemen, I’m begin-
ning to—yield?

Mr. Towns. I’m done. [Laughter.]

Mr. Suays. I’m beginning to think that we may need three hear-
ings and we're all trying to combine too much into one hearing, and
I appreciate the patience of the panel. I note, Dr. Gramlich, that
you were looking at your watch, and I know we're going pretty long
here, but, I’m concerned that we haven't established some basic
points here that I feel that the committee would be derelict if we
didn’t establish. One of them is going to be what in the Boskin
Commission should BLS be concerned about? And what aren’t they
doing what they should be doing? I mean, that’s one, and I’m not
going to ask that right away.

First, I want to know what are the known potential sources of
downward CPI bias in the current structure? And rather than
starting with Dr. Abraham, I’m going to start with Dr. Gordon or
Dr. Gramlich. What are the known downward biases that exist?

Mr. GorDON. There is literature on downward biases that were
important in the past, and that the BLS discovered on its own and
largely addressed. Particularly, for rental housing and apparel.

Mr. Suays. Rental housing and apparel?

Mr. Gorpon. And I believe both of those were basically fixed in
the late 1980’s. I’m not aware that there is an important category
where there’s any kind of consensus that there’s a downward bias.

Mr. SHAyYS. Well, I think in our next panel we're going to have
some dialog about that so 1 wanted to make sure it was covered
here. Dr. Gramlich?

Mr. GRAMLICH. I’m going to have to pass on that one, Mr. Chair-
man.

Mr. Suays. OK.

Mr. GRAMLICH. I am not aware, that doesn’t mean there aren’t
any.

Mr. Suays. Is anyone from GAO able to respond? Are there any
potential downward biases in the CPI?

Mr. UnGaRr. I don’t think we have any.

Mr. Suays. Dr. Abraham?

Ms. ABRAHAM. There are places where people have suggested
that if you look you might find evidence of downward bias. The
thing that comes most to mind is the quality of service in retail and
other services establishments generall , but as is true with many
aspects of bias associated with changes in the quality of goods and
services, the evidence is sparse to non-existent.

Mr. SHays. Now, we talked about the so-called “low-hanging
fruit” of the Boskin Commission. I want you to define what that
low-hanging fruit is, and, Dr. Gordon, what you thought it was and
what you think BLS has done to date to deal with the low-hang-
ing—the so-called easier issues to deal with?

Mr. GORDON. We have these four categories: upper-level, lower-
level, substitution bias——

Mr. SHAys. Right.

Mr. GorDON [continuing]. Outlay substitution bias, and the big
area of quality change in new products. The low-hanging fruit, No.
1, was the geometric mean solution to lower-level substitution bias.

Mr. SHAYS. That was the 0.2 percent change in the CPI?


102

Mr. Suays. OK, I'd like it. You know, I welcome opinions espe-
cially at the end.

Mr. GORDON. The BLS data on inflation is very timely.

Mr. Suays. OK.

Mr. GoRDON. It comes out a month or so after the prices are col-
lected in the field. The weights with which those individual price
changes are put together, since there are thousands of them, are
less up to date than would be desirable because they're based on
1993-1995 and that’s now 4, on average, roughly 4 years old. It
doesn’t_ make—

Mr. SHays. And what do you think——

Mr. GorDON [continuing]. That much difference.

Mr. SHays. OK, that’s fair to know. And it doesn’t make that
much difference because the weights aren’t as important?

Mr. GorDOoN. Because the weights don’t change that much, be-
cause——

Mr. Says. OK.

Mr. GorDON [continuing]. The big items like food, shelter, insur-
ance are not either changing as a huge percent of the consumer
budget from one decade to another nor are the rates of inflation for
those items so radically different from each other that the
weighting matters. Where it matters are items that have very
atypical patterns of price change, especially things like computers,
cell phones, long distance phone service.

You, the front page of the Wall Street Journal last week, had a
story on the competitive battle for cellular phones in Jacksonville,
FL, with six companies fighting it out and the price over the last
year has gone down 46 percent according to that story. That’s the
kind of items where you need accurate up-to-date weights. One
strategy that the BLS could take, and it sounds as if they are sym-
pathetic to this idea, is maybe you don’t have to update all the
weights every year, but maybe there is a subset of the consumer
market basket where there is dynamic change going on and you al-
locate more resources to that, collect data for the larger sample
more frequently, and achieve a greater level of accuracy.

Mr. SHays. That seems like a sensible, you know, idea. I noticed
that you were nodding your head, Dr. Abraham. You'll get your
chance to translate your nodding of your head. Dr. Gramlich.

Mr. GRAMLICH. It is clearly a timely index but in terms of its
quality I think it didn’t used to be a very, particularly good index,
or particularly updated index, but I think the BLS has made a lot
of changes that makes it much better and more current. As I said
in my testimony, another big step in that direction would be to get
a revisable index that changes the weight for this upper level prob-
lem that we think the BLS could do fairly soon. It would entail re-
vising the index and we think that probably ought to happen and
could be dealt with. There are a number of other issues that Bob
mentioned that are farther down the road, and I think we would
all like to see the BLS study those carefully and presumably make
some changes, but these are more complicated, would take more
study. So I would like to see the BLS keep at it. But I do think
the step of getting a revisable index dealing with upper level sub-
stitution bias would be something that would be a welcome change
fairly soon.


118

program of research and development activities aimed at improving the CPI. Since 1990, the BLS
has implemented a number of improvements in addition to the soon to be completed six-year CPI
revision program.' The effect of these improvements, combined with the major CPI revision
program, will effectively reduce the rate of increase in the CPI by almost 0.7 percentage points per
year.’ These changes alone will save taxpayers approximately $100 billion in federal outlays and
interest payments between now and FY 2003.'°

‘As a result of the increased focus on the CPI caused by the Boskin Coramission report, the
BLS has also begun a new multi-year CPI Improvement Initiative. In FY 1998, the BLS received
$2.1 million for the first year of the Initiative and has asked for $9.1 million in FY 1999. According
to the BLS, these funds will expand the Consumer Expenditure Survey to facilitate more timely
CPI market basket updates and the production of an official superlative index that is more accurate
than the current CPI. The new funding will also enable the BLS to significantly expand the use of
hedonic quality adjustment methods and reduce the CPT's reliance on linking methods for new
products.

Recommendations:

Congressional action is not immediately necessary, but oversight is critical. The President
and Secretary of Labor have authority to direct the BLS to correct the CPI as part of the current
Improvement Initiative. Funding for this important project should be found within the existing
discretionary budget.

The Secretary of Labor should establish a cost-of-living index as the BLS's objective in
measuring consumer prices. A perfect cost-of-living index may not be possible in a complex
economy, but the BLS should continually strive for that goal.

‘The Secretary of Labor should establish a permanent and rotating independent commission
of experts to review progress, conduct research, and make recommendations to further improve to
the CPI. The commission should be appointed by either the National Bureau of Economic Research
or the National Academy of Sciences and report the Congress once a year. If the Secretary of Labor
does not establish such a commission this year, Congress should implement one through the
appropriation process with the reprioritization of existing resources. Thirty years between the
Stilger and Boskin commissions is far to long.

‘only with a long lag); 4) a quality change bias (the price increases related to medical services are not adjusted for
increases in the quality of care). There is also a temporal substitution bias (consumers purchase items on the
‘weekends when products are on sale).

* The BLS has revised its methods for making seasonal adjustments; introduced procedures to capture the effect of
‘generic drugs in reducing prices; changed the way shelter prices are estimated for renters and homeowners;
corrected a flaw in the weights attached to new items in the CPI sample; and reclassified the services provided to
hospitals to capture patterns of treatment better.

* Max R. Lyons, “Employment Policy Based on The Consumer Price index: Roughly Right or Precisely Wrong?”
Employment Policy Foundation Fact & Fallacy, Volume 1V, No. 4, April 1998.

" Heritage Foundation calculation based on: Scott A. Hodge, “Ending the Era of Big Government: Balancing
‘America’s Budget,” The Heritage Foundation, 1997.


65

Overall, BLS’ fiscal year 1999 performance plan would partially meet the criteria in the
Results Act and related guidance, although, as stated previously, we recognize that the
plan was not required to comply with the statutory requirements. Considering that this is
the first Results Act performance plan that BLS has produced, the plan contains a great
deal of useful information to inform Congress and others about how BLS intends to
accomplish its mission. We expect that as BLS gains experience, future performance
plans will build upon this initial effort and become increasingly more useful to Congress.
and the public. Specifically with respect to the CPI, BLS’ fiscal year 1999 performance
plan provides a partial picture of BLS! intended »erformance relative to its goals aimed at
improving the quality of the CPI. Further, the plan does not fully portray how BLS’
strategies and resources will help achieve BLS’ performance goals for improving CPL
quality or how BLS will ensure that information it uses to assess actual performance

against CPI improvement goals is accurate, complete, and consistent,

Under the criteria in the Results Act and related guidance, agency annual performance
plans are to contain goals for each of the program activities identified in the agency's,
budget and should express them in objective, quantifiable, and measurable form to allow
comparison between actual and planned performance. Agencies can use their discretion
in determining their performance goals. Agency plans should also contain indicators to
be used in measuring or assessing the relevant outputs, service levels, and outcomes of
each program activity. In our view, BLS’ performance goals associated with improving

the quality of the CPI, which are shown in appendix I, are linked to its budget and are


n

BLS' views on these recommendations, we relied upon a written statement BLS sent to
the Chairman of the Joint Economic Committee in June 1997." BLS has provided
Congress with its views on the Boskin commission report on several occasions; for
example, in addition to the June 1997 statement, it also provided testimony to the Senate
Budget Committee in January 1997 and to the House Budget Committee in March 1997.
BLS informed us that any Boskin commission recommendation for which linkages cannot
be identified in its strategic plan were those that either restate current BLS/CPI policy,
are presently in development, or have been explicitly rejected by BLS, Further, BLS said
that it had initiated work related to many of the areas covered by the Boskin

commission's recommendations prior to the issuance of the commission's report.

BLS told us that both it and the Department of Labor question the usefulness of
discussing recommendations contained in particular reports, such as the Boskin
commission report, in long-range planning documents, including BLS’ strategic plan and
fiscal year 1999 annual performance plan. However, given the high degree of interest that
Members of Congress, the Federal Reserve, and others who are concerned about the
accuracy of the CPI have shown in the Boskin commission's report and
recommendations, we believe that a discussion of the relationship of the goals in BLS’

performance plan for fiscal year 2000 to the Boskin commission recommendations, or an

“BLS, "Measurement Issues in the Consumer Price Index," paper prepared in response to
a letter from Representative Jim Saxton, Chairman of the Joint Economic Committee,
June 1997.

20


16

timeliness and accuracy of the CPI. For Fiscal Year 1999,
our request seeks a total of $11.2 million and 47 FTE for
the second phase of a three-year buildup to put this

improvement program in place. The proposal has four major

pieces.

First, in order to improve the timeliness of future CPI
Revisions, we are proposing an expansion of approximately
50 percent in the size of the sample of households that
supports the Consumer Expenditure Survey. About four-
fifths of the proposed cost of the CPI Improvement proposal
would be devoted to this project. At the present time,
three years of expenditure data are required to construct a
CPI market basket with an acceptable degree of accuracy.
The proposed expansion will reduce the number of years of
expenditure data required to two. Combined with a separate
project to modernize the CPI market basket update system,
this expansion will allow the BLS to reduce substantially
the lag between collection of expenditure information and
the introduction of future updated CPI market baskets. If
funded, this proposed change will greatly enhance the
Bureau’s ability to adopt a policy of more frequent weight

updates.


99

Mr. UNGaR. But subsequently there was a matter discussed that
wasn’t labeled a recommendation that the commission said should
have been.

Mr. SHays. OK, well, one is the general overview and then you
had the short-run and then you had the intermediate-run, and then
you had the long-run?

Mr. UnGar. Right.

Mr. SHays. And when we get into the intermediate-run and the
long-run, there really don’t seem to be any BLS performance goals
and therefore no ability to assess whether—now just pick out one
as an example and let's see if we can learn something from this?

Mr. UnGakr. I'll do that, Mr. Chairman, now let’s say if we could
pick No. 5 for example——

Mr. SHays. OK.

Mr. UnGak. I just wanted to clarify, I’m sorry five——

Mr. Suays. Do you want to clarify first or do you want?

Mr. Unaar. I just want to clarify the table. What the table is
really portraying is the linkage between what's in BLS’ strategic
plan in terms of performance goals in the commission’s report. It
doesn’t necessarily mean that they’re not doing anything in BLS in
some of these areas.

Mr. Suays. OK.

Mr. UNGAR. And what we found was that—

Mr. Suays. So, let me be sure, Dr. Gramlich, that we’re not, that
you’re able to hear so you're able to respond. The bottom line is
that Congress intends for all the bureaus, divisions, and depart-
ments to have strategic plans, and then for Congress and GAO to
be able to assess how well we’re doing, and so you’re saying under
intermediate run, and let me read it. No. 5 is:

BLS should study the behavior of the individual components of the index to ascer-
tain which components provide most information on the future long-term move-
ments in the index, and which items have fluctuations that are largely unrelated
to the total and emphasize the former in its data collection activities.

Boy, that is a mouthful.

Mr. Unaar. Right. Now, as I indicated, there were eight here in
total that we didn’t see a linkage for. This No. 5 happens to be one
that BLS disagrees with. And there are two others like that. So,
therefore, BLS told us it really didn’t have anything underway with
respect to that No. 5 plus two others.

Mr. SHays. Excuse me, let me just interrupt a second. There’s so
much movement here. Dr. Gramlich, do you have a time problem
or anything that we need to be aware of? Pardon me?

Mr. GRAMLICH. I’m all right for a while.

Mr. SHays. OK, I want to be respectful. You’ve been here a
while, and Dr. Gordon do you have any time problem?

Mr. Gorpow. I'd like us to be done in 10 or 15 minutes.

Mr. Suays. OK, well, we'll see if we can accommodate that.

Mr. Towns. Otherwise or you’d like to leave. [Laughter.]

Mr. SHAys. OK. Let me just say if we get cooperation from the
subcommittee, I have no long speeches. We can be done in 15 min-
utes. Would you continue?

Mr. Uncar. Sure, I think recommendations Nos. 5, 10, and 12
are those with which BLS said it really rejected, and, therefore, it
disagreed with and doesn’t have anything ongoing. Although, I


21

egories that the BLS is already going to correct in its changes next
year.

Mr. Suays. So upper is substitution among categories, and lower
is substitution within categories?

Mr. GRAMLICH. That's right. On an experimental bias, the BLS
already produces superlative indices dealing with this upper level
substitution bias, but these indices are only available with a con-
siderable lag. Using data from recent decades, several studies have
constructed indices to take full account of consumer substitution
and have used these indices as benchmarks to compare to the ac-
tual CPI. Through such comparisons, it is possible to assess the
amount of bias in the CPI arising from this upper-level substitution
bias. Although estimates depend in the time period and other par-
ticulars, the research broadly suggests that the changes in this
upper-level substitution bias could reduce the rate of change in the
CPI by about 0.2 percentage points a year. For example, if the cur-
rent CPI showed an increase of 2.0 percent a year, year over year,
then after correcting for this type of substitution bias, the CPI
could be expected to show an increase of about 1.8 percent a year.
This might not sound like much but, compounded over many years,
such a change would have marked implications for any program or
contract that is indexed to the CPI.

To correct fully for upper-level substitution bias, it would be nec-
essary to know how market baskets change on a regular basis in
order to capture the substitution among different items. The ex-
penditure data required for such calculations are obtained from the
consumer expenditure survey. Because of collection and processing
time, these data are only available with a lag so that the figures
for 1997 are not expected to be available until later this year. Thus,
the data from the consumer expenditure survey cannot be used to
construct a real time price index that fully captures consumer sub-
stitution among items. This lag is the reason that BLS’ experi-
mental superlative index is only available with a delay.

It is possible to deal with the problem. And this is the main point
T'd like to make. The Boskin Commission, represented today by
Robert Gordon, suggested as a possible solution of the use of some-
thing known as a “trailing Tornqvist price index.” This index would
use an index formula which can capture substitution among items
that would update weights each year. To be operational in real
time, the index would need to use lagged or trailing weights. For
example, the average weights from 1994 to 1995 could be used for
calculating the 1997 changes in the cost of living. There are other
approaches suggested by economists that approximate this type of
thing.

One approach that this subcommittee could consider would be to
commission a study of substitution bias to be undertaken by the
staff of the BLS. The BLS could be asked to compare their current
procedures with those that have been proposed by these other re-
searchers. They could determine which of these alternative ap-
proaches provides the most timely and accurate approximation to
the superlative index, published by the BLS. Recalling that while
the superlative indices may be the best, they are only available
with a considerable lag.


50

statute to issue a strategic plan or a performance plan. The Depart-
ment of Labor is required to do so. It did prepare a plan and in-
cluded BLS’ material. However, I would note that the Department
of Labor did instruct its components, including BLS, to prepare
both strategic plans and performance plans to cover their own ac-
tivities. And, of course, BLS did so.

In terms of BLS’ 1999 performance plan, we noted that it did in-
clude at least seven objectives, or excuse me, seven performance
goals that were specifically related to improving the accuracy or
the quality of the CPI. We also felt that, given this was the first
year for which the act required such plans, that BLS did a reason-
ably good job of identifying the major aspects, the major compo-
nents or topics that are required to be covered in the plan. We be-
lieve that with continued experience BLS will certainly do much
better in the future.

There were a few areas where we thought BLS could improve its
plan, and particularly in terms of how useful it would be to others,
outside of BLS, in looking at the plan. For example, as BLS notes,
all of its goals and the indicators that are associated with those
goals are really stated in output terms or activity terms, not in out-
come terms. Also, they’re very generally stated; they’re not nu-
meric, they're all measurable, but we think they could be a little
more specific. For example, on its goal to expand the size of the
CEX sample size, it mentions that as a goal but it doesn’t give ex-
actly, as a part of the goal, how large it’s going to be and what the
base has been; so, it would be difficult for somebody looking at that
to tell exactly how much progress BLS has made at the end of the

ear.

x The other area that we would suggest BLS look at for the next
plan, which would be for 2000, would be to have more detail or a
better description of how it intends to verify or validate the data
that it will be using to determine whether or not it met its seven
performance goals. It currently does include a description in its
plan of what it intends to do. Although, again, it does mention that
it’s basically activity oriented or milestone achievement, not out-
come oriented. Since all the seven performance goals relate to im-
provement in accuracy, or related outcomes, it appeared to us that
it would be helpful to have some insight as to how BLS might go
about showing that those performance goals will be met in terms
of improved accuracy.

The second broad issue that we looked at with respect to BLS’
efforts under the Results Act had to do with a comparison, at the
subcommittee’s request, of the extent to which the BLS strategic
plan, and the performance goals indicated therein, link up to the
Boskin Commission recommendations that were made to BLS. The
Boskin Commission report specifically identified 12 recommenda-
tions to BLS. Subsequently, the commission noted that another
issue that it had discussed in the report actually should have been
a recommendation. It was not labeled as such, so, there is a total
of 13 recommendations to BLS. We did not see a linkage between
BLS’ performance goals and indicators for eight of those rec-
ommendations. I might add that the BLS is certainly not required
to have particular types or subject matters covered in its goals.
That’s something that’s at its discretion. They did, however, have


95

middle class. I think there’s some things that we could do to get
information maybe to bring about answers to those kind of ques-
tions, and I think that, to me, this is very, very serious because
when you're talking about somebody in terms of buying, being able
to buy a VCR, somebody else will not be able to buy food. And I
think that’s what we're talking about here. And I come from an
area that when we talk about the discounts in the stores and all
that, I come from an area where they're not there. And that’s a
concern, And I think information like this when we look—I would
like to have some additional kinds of information on those kinds of
questions. And I think that it’s only fair to request that. And we’re
not talking about an ongoing thing but I think there’s some things
that you could do, at this particular point, to give an answer. I
think in terms of the middle class, I think that’s just there, that
we have that kind of project in place to be able to answer those
kinds of questions. I think that that’s reasonable, you know, if it
costs a few more dollars then let’s spend it because I think that
when it comes to credibility, I think that’s also an issue here, and
I’m not questioning yours at all. For instance, I want to let you
know, I like you.

Ms. ABRAHAM. Thank you. I would be happy to come talk with
you privately about what we're currently doing and what other
things might be feasible to do at what cost.

Mr. Towns. Let me ask you, and then I’m going to close, Mr.
Chairman. You know, I think about when the VCR’s that came out
initially. First of all, we had the Beta, and after, VHS first, and
then after that the Beta. And then the question is, is this included
in the calculations that would change the price as a result. I think
that when you first got involved it was only the one and then after
that, no one had any idea as to where the price was really going
to go and then after that point, there was a change and I don’t see
whether that would be reflected. I don’t see how you could reflect
that. And those are the kinds of things that I think that I’m con-
cerned about. And if I’m wrong, tell me I’m wrong. I mean, I’ve
been wrong once before, a long time ago though. [Laughter.]

Mr. Gorpon. We, I think the BLS agrees with the basic propo-
sition that unfortunately some products were introduced late into
the CPI relative to the time they were introduced into the market-
place. This is a longstanding problem. The automobile wasn’t intro-
duced into the CPI until 1935 and yet people were driving them in
1906. So I think the——

Mr. Towns. I think you’re agreeing with me.

Mr. Gorpon. | think the recommendations that the market bas-
ket be updated as often as possible handles this problem because
as you update the market basket, you're going to capture these new
more modern products earlier in their cycle.

Mr. Towns. Yes, and I’m not sure I’m making myself clear, that
they introduce after the price comes down that’s what I’m really
trying to say here and that’s the concern I have. For instance, you
know—

Mr. GorpDoN. That was our point in the report.

Mr. Towns. Yes.

Mr. GORDON. That we’re missing some of the price declines the
later we introduce these things.


33

set of weights which would change every year, the so-called trailing
Torngqvist idea.

There’s been no mention yet, today, of the problem of outlet sub-
stitution bias. One reason is there's been almost no research on
that, academic or otherwise. We know by one index that the share
of discount department stores has increased from 45 to 65 percent
of total sales over the past decade, but I don’t know of any meas-
ures yet that would produce a measure of the average discount at
that group of stores compared to more traditional stores. The BLS
needs to carry out itself, or fund in the academic community, a
major research effort to collect data on retail price differentials to
complement existing data on sales by type of stores that we already
have in the census of retailing.

We've seen no response yet to our recommendations that the pat-
tern of data collection be updated and improved. At present, too
many resources are devoted to collecting prices at the local level.
There are thousands of price quotes for bananas in at least 40 dif-
ferent metropolitan areas. The bananas are imported. How dif-
ferent can the price of bananas be in Boston versus Burbank, or
in Burlington versus Burbank, I should say? By eliminating some
of this redundant data collection, the BLS could free up resources
for a more concerted effort to introduce new products more prompt-
ly. But let me emphasize that our recommendation for a second re-
search-based index certainly needs adequate and additional re-
sources, and we wouldn’t claim that they could do everything we're
suggesting simply by reallocating their current budget.

The current agenda of BLS initiatives represents progress within
the current framework, but reveals little willingness so far to open
up and reconstruct the framework itself. Something like nibbling
around the edges, without taking a bite out of the core. The com-
mission agrees with the BLS that we do not believe it is possible
to produce a perfect index, partly because some of these quality im-
provements and new products contributions are intangible. But
commission members do not agree that the Congress, or the Amer-
ican people, should be satisfied with the failure thus far of the BLS
to confront the core of the Boskin Commission recommendations.

Thank you.

[The prepared statement of Mr. Gordon follows:]


133

Finally, this Committee solicits input about what Congress can do. While there may be
differences of opinion about research and implementation priorities, there should be no
disagreement with the view that the BLS must remain independent of the political process.
Congress needs to know what the BLS plans to do before it can appropriate funds, but those plans
must be developed independently by the BLS, free from interference from any quarter. Some have
recommended that a permanent, independent, public, professional entity be established and funded
by the BLS to provide research input. But, the BLS already has a formal mechanism to do this.
It has business and labor research advisory committees. Perhaps, it could establish an academic

research advisory committee. Any more formal mechanism would facilitate politicization.

The BLS would be better advised to consider establishing arrangements with national
laboratories, such as the National Institute of Science and Technology (NIST) to get the kind of
technical advice needed to identify new products and evaluate quality change. Other agencies the
BLS could draw on are the National Institute of Health research arms, the Consumer Product
Safety Commission and the Environmental Protection Agency. Economists should not be put in

the position of playing the roles of engineers, doctors, and environmental sciemtists.

‘The BLS has taken the first steps toward a COLI. But the public needs to know promptly

the rest of its plan. Perhaps, these hearings will act as a catalyst to that end.


17

In addition to supporting more timely updates of CPI
expenditure weights, the expanded sample for the Consumer
Expenditure Survey also will support the publication of
production-quality superlative indexes which, as I
mentioned in last year’s testimony, will account for
substitution across CPI item categories in response to
relative price changes. At present, these measures are
produced on an experimental basis, and the CPI improvement
proposal will provide us with the additional resources
needed to produce them on a regular schedule, to a higher

standard of precision and reliability.

Finally, we are requesting funds to support expanded
pricing of goods and services together with the collection
of richer information on those items’ characteristics, to
support additional regression-based quality adjustment
applications. While it is not possible to predict the
outcome of this work in advance, we do know that
application of these methods has proven to be of value in
improving adjustments for changes in product
characteristics. In addition, for particular item groups
that are greatly affected by the introduction of new goods,

BLS will be able to replace or augment existing samples of


61

conducted by BLS tend to show lower rates of inflation with indexes using newer

weights.

Since last fall when we received the Commissioner's comments, the Commissioner has
told this Subcommittee that BLS is committed to more frequent updating of the weights
used to calculate the CPI. In March 1998, the Commissioner said that, although BLS had
not yet decided on the optimal frequency of weight updates, it was clear that a reduction

in the current (approximately 10-year) period between updatings was warranted.

CURRENT GAO WORK ON THE CPI

At the request of the Ranking Minority Member of the Senate Committee on
Governmental Affairs, the Honorable John Glenn, we are gathering information from BLS
related to the quality adjustment issues raised by the Boskin commission. To better
inform policymakers and other commentators on this issue, we have been asked to
describe the policies, procedures, and practices that BLS currently uses to account for
differences between a new item and the item it replaced. This replacement process is
necessary when an item is no longer available for BLS to price. Within this process, BLS
determines if the new item is comparable to (ie., the same as) the old item that
disappeared. We are in the process of collecting information to describe what BLS does

when the two items are not comparable. We anticipate issuing our report early next year.


130

implemented, then reversed and to this day the treatment of environmental costs is not handled

properly in the CPI when viewed from a cost-of-living perspective.

The Boskin report and other economists now advocate the treatment I had recommended
over 25 years ago. Yet, no plans to correct this problem have come to my attention in BLS’
statements. The BLS passed up an opportunity to adopt this recommended approach when several
years ago it chose to treat the higher pump-price of the special environmental winter blend of
‘gasoline as a quality change, even though it was not related to its ability to improve the operational
performance of autos. The BLS should reverse this procedure as soon as possible. That can be
done quickly. Data and estimates exist. They were used in BLS’ aborted attempt to do it in 1971
and have been used by the CBO and the Boskin panel. The effect can be quantified. And the BLS
should expand its investigation of other goods and services that cost more because of requirements
that they be produced in a more environmentally friendly way. Surely other items, besides auto-
related ones, now cost more without a corresponding increase in their quality in providing their

basic service.

But that step as well as the aforementioned adjustments for substitution among market
basket items in response to relative price change are only the first ones necessary if the CPI is to

move to a COLI.

‘There is another key conceptual issue critical to the empirical implementation of a COLI.
It involves how the index family is defined and how weights are developed and a sample of items

4


114

7

Third, it has announced that most lower level indexes will be computed in the future by the
geometric mean method, This replaces the old arithmetic mean method for lower level indexes,
which has been shown to have serious faults.

Additional reduction of weighting effects, and substitution bias, in the CPI can be accomplished
by expanding the Consumer Expenditure Survey, and improving its data. An expanded
expenditure survey will permit CPI weights drawn from one year’s survey data, instead of the
average of three years’ data, as now. It will also make it possible to reduce substantially the time
it takes to bring new weights into the index, so in the future the weights can be more nearly
current than they are at present, where the new weights are already roughly four years out of date.

BLS research has led to most of the knowledge about substitution bias and lower level index
number problems in the CPI. Because the payoff to resources devoted to research has been so
high, assuring continued resources to the BLS research function is possibly the most valuable
step that can be taken to assure future improvements to the CPI.


116

Mr. WILSON. Well, to the degree that the CPI and the measured
inflation influences inflation expectations as well as the market's
perception of inflation, that will then affect both Government as
well as private interest rates.

To go on, to touch on here, I think that it’s important to note
that the BLS received in this fiscal year $2.1 million to, as first
year of their CPI Improvement Initiative Program, and they’ve
asked for $9.1 million in fiscal year 1999, a substantial amount of
money. These funds will be used to expand the consumer expendi-
ture survey, to facilitate more timely CPI market basket updates
that have been touched on, and also to begin the production of an
official superlative index, which I think are both positive steps, but
certainly long overdue.

I think we all agree that congressional action is certainly not
necessary but oversight such as this hearing and other hearings
are critical. I would strongly encourage at least annual oversight
hearings. The Secretary, I believe, the Secretary of Labor should
establish a permanent and rotating independent commission of ex-
perts that’s focused specifically on the Consumer Price Index.
There are advisory panels at the BLS, but I think one that focuses
exclusively on the CPI would be productive.

I think that it’s important that the BLS establish a new index
that’s published and updated annually and revised historically as
far as possible. The index would take immediately into account all
changes made to the CPI since 1990, and any further improve-
ments that are made to the official CPI. This new index could then
be used much like the current CPI UX-1, that’s published in the
Economic Report of the President, is used as a deflator in economic
research.

This morning there was some discussion, of the average family
income concept CPI. I think the solution there, to touch on those
issues, is certainly an expansion and improvement of the consumer
expenditure survey, with that I think such an experimental meas-
ure could be developed. I think that expanding the point-of-pur-
chase survey and improving that survey would help facilitate an
experimental elderly index. And I think it was also very good to
have GAO’s views on how well the BLS meet the requirements of
GEPRA.

Thank you.

[The prepared statement of Mr. Wilson follows:]


4

mentioned how this might be done. Gee, just a half a percentage
point and we can save billions and billions of dollars and who’s
goin to know it? Boy, and maybe we could even give more tax

reaks to billionaires because they know it. They’re down here and
their friends are here everyday telling us how much more they
need these tax breaks. So I regard, it is one thing to have a serious
discussion, which is a difficult discussion, we'll have it today, I
guess, about how we determine what the CPI is. But, Mr. Chair-
man, I would hope very much that we do not develop this whole
discussion as a back door way to cut back on help that millions of
Americans are entitled to, and that millions of Americans need in
order to save the Government money so that maybe we can repeat
what we did last year and that is cut taxes by $130 billion, much
of which goes to the rich. Or maybe we can cut Medicare by $115
billion. So let’s not do that. Let’s have an honest discussion of what
CPI is, but let’s not do it as a back way to save the Government
money and then build B-2 bombers, get corporate welfare out
there, or give huge tax breaks to the rich.

Now, how do you determine the CPI? Boy, I don’t envy any body
up there. That is a tough issue. And I, maybe some of you will com-
ment on this, but it seems to me that if I were an 18 or 20-year-
old kid living in Los Angeles, CA, and I had my purchasing needs,
and I was going out purchasing my first computer, and my stereo,
or whatever 18 or 20-year-old’s purchase, that is one thing. It’s
hard enough to determine that. But let me tell you something from
the bottom of my heart that 80-year-old women in the State of Ver-
mont—and I remember this discussion the last, that somebody on
this committee said, “Gee, I remember, I bought a computer 10
years ago, and I paid huge sums of money. I just bought a much

etter computer for a lot less money.” Gee, you know, you got to
take that into account when you do your CPI.

Eighty-year-old widows in the State of Vermont are not out buy-
ing computers, that I can tell you, nor are they buying new stereos.
You know what they’re trying to do? They’re trying to buy prescrip-
tion drugs in order to stay alive. They’re trying to heat their homes
when the weather gets 20 below zero. So, frankly, I do not have
a clue as to how you can even come up with a CPI for 20-year-old
kids in California and 80-year-old women in the State of Vermont.
Those are two different worlds. And if we’re going to talk about So-
cial Security, then we have to say, “fine.”

If the thesis that we're operating under, as I understand it, Mr.
Chairman, is that every year we're supposed to give a cost of living
based on inflation. Then the inflation should be relevant to the peo-
ple who are affected.

And my constituents in the State of Vermont, do you know what
happened to them in the last year? They're paying a 30- or 40-per-
cent increase in their Medigap. Do you know what Medigap is?
Medigap is the cost of what they’re paying for insurance that Medi-
care doesn’t cover. Thirty-, forty-percent increase. They're paying
off the wall prices for prescription drugs.

So I would suggest very strongly, Mr. Chairman, that we move
toward, if we’re looking at Social Security, if we’re looking at Social
Security and the needs of the elderly, that you need a calculation
which is based on their needs. I would argue, and maybe there are


93

is you have a certain amount of wealth and if the system works
right you have a little more wealth. That’s the old formula. [Laugh-
ter.

Now, the new formula, given the CPI changes with your geo-
metric mean means that wealth accelerates quickly to the top so
you have a little bit of wealth and you have even greater wealth.
So my question to you is this. I listened to your testimony. It seems
to me you haven't quite analyzed the impact of the substitution ef-
fect of outlet, substitution effect and the quality effect as a respon-
sive mechanism in the redistribution of the wealth. And since you
haven’t really done that, how could you be sure that a downward
revision of the CPI would not have a direct result of redistributing
the wealth even further? Any one want to try that? That’s this for-
mula.

Mr. Gorpon. If we were in a different room, in a different com-
mittee, on a different topic, I would tell you that I agree with both
of you two gentlemen. We do not tax the rich nearly enough and
the Michael Eisners, the Michael Jordans of the world would still
be doing exactly the same thing they are doing today if you added
a marginal tax rate at the top of 50 or 60 percent instead of 39.
But that’s not what we're here to talk about. We’re here to talk
about the most accurate possible measure of the cost of living.

Mr. Kucinicu. That’s what you're here to talk about.

Mr. Suays. No, you're free to talk about whatever you want but
this hearing is about the accuracy of the CPI.

Mr. KucInicu. But, please, I have a great respect for the Chair,
but I just want to make sure that I understand what, and you're
talking about it very well, thank you, I will assert that and give
the gentleman his due, you're talking about it very well. But what
I’m stating is, permit me the liberty, as a Member of Congress, to
shift the context if I might because there is a larger context here.
There is, when the stock market goes above 9,000, there’s wealth
that’s being redistributed upward and I’m happy for my constitu-
ents who are part of that. But I also recognize there’s some who
aren’t. So you draw up your presumption, your modeling is based
on certain economic conditions, market baskets, et cetera.

My question to you is where do you take into account the climate
where wealth is being accelerated to the top much more quickly
and there’s greater disparity between the rich and the poor, so
much so we know you change the CPI, it impacts on the middle
class. We know that. And so if you’re going to do that, and you're
not doing it in response to these questions, do you even think about
those things?

Ms. ABRAHAM. No, we don’t, and I believe we shouldn’t. Our goal
is to produce the most accurate measure we possibly can. How peo-
ple use that, what decisions you as policymakers make about how
that measure is, or isn’t, going to be used are really not questions
we appropriately could address. And I think that if we were to
start getting into those kinds of questions you would quite appro-
priately have concern about our objectivity.

Mr. Kucinicu. I’m glad, I’m glad you clarified that because when
I go back to senior citizens in my district who are concerned that
a downward revision in the CPI will result in lower Social Security
checks and them not being able to keep up with the cost of living,


38

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 5

of every American..

While some of the numbers we applied to particular categories in our quality change
evaluation may have been too high, others are too low. A subsequent study of cellular
phones by Hausman (1997) identified a major bias in the telephone category which we did
not take into account, and suggestions to us by Robert E. Hall and others indicate that the
CPI understates the rate of decline of long-distance teleplione service prices by substantially
more than we recognized. My own studies of quality-adjusted prices of television sets, as
well as a BLS study of television sets for a shorter period, indicate a major upward bias in
the CPI for that product category?

We thought hard about what we might have left out, that is, omitted sources of bias
in either direction. There are many dimensions of quality improvement which academic
research has not and probably never will capture, including the faster speed and reduced
vibration of jet planes compared to piston planes (including the regional jets currently being
introduced), improved reliability and safety of appliances and automobiles, improved sound
quality of audio equipment, reduction in the noise, weight, and installation cost of room air
conditioners, and immeasurably better picture quality of color TV sets. In its latest May
1998 issue, Consumer Reports advises consumers when to repair old products and when to

replace them, and along the way it creates a new list of quality improvements that are not

3. My study covered 1983-97 and is based both on the Sears catalogue and on Consumer Reports.
The unpublished BLS study by Moulton and co-authors used the hedonic price technique and covered
more models although over a shorter period (1993-97). The Moulton study found an upward bias in the
CPI at roughly the same rate as assumed in our report, about 3 percent per annum. My study found an
upward bias of S to 6 percent.


125

Now, let me come to what I think is a more important issue but
it was touched on this morning. It’s the issue of the index family.
Whose cost of living should be measured in measuring the cost of
living? The Boskin Commission really never addressed this issue.
However, increasingly economists are coming to address it. And I
would point to a recent symposia published in one of the leading
journals of the American Economic Review in which there was a
report, there was an article by Boskin, but two of the other articles
had to do with this issue of what is the index family and how do
you do a price index for that index family? And I think that that
issue was raised by several members of the committee this morn-
ing. And what they were talking about, let me characterize it this
way, I think the panel understands that when you just add up dol-
lars of spending for the whole economy and do a percentage dis-

ibution, that the Cadillacs weigh more heavily than the used cars
in terms of pushing up-the weight of automobiles in the index, for
example.

My proposal is that you take the pertentage distribution in each
household from this consumer expenditure survey that was dis-
cussed this morning, take the percentage distribution in each
household. Household A spending 2 percent on this, 4 percent on
that, and you average the percentage distributions in each house-
hold, and that way there will not be the over weighting of the
spending of the upper income part of the income distribution.

The question was asked this morning, “Who does the CPI rep-
resent?” That question was answered in the same symposia that I
referred to by Professor Deaton from Princeton. He said that the
CPI can best be characterized as capturing\the prices paid by some-
one who is at the 75th percentile of the income distribution. That
is 75 percent up from the bottom, and 25 percent from the top.

Mr. SHays. Which would be about approximately what income?

Mr. Popkin. I would guess it would be above $75,000.

Mr. SHays. Yes, that’s what I was——

Mr. Popkin. I think. So that’s something that I think that if the
committee——

Mr. SHays. Only because I interrupted him. I’ve cut your clock
only because I’ve interrupted and I——

Mr. PopKIN. Did you restart it, it’s OK?

Mr. SuHays. No, we’re just going to let you——

Mr. Towns. He just shut it down. [Laughter.]

Mr. Suays. I just shut it down.

Mr. Popkin. Oh, OK, OK.

Mr. SuHays. But I don’t want you to——

Mr. PopKIN. Well, I am trying to move along, I realize it’s late
in the day and we’re all——

Mr. Suays. But I have interrupted you.

Mr. Popkin. And one of the reasons I think it’s important that
the BLS move first to decide these index family issues and how it’s
going to weight the index is because that affects the quality adjust-
ment problem. One of the witnesses this morning kept stressing
the need for more quality adjustment. I don’t think you know how
to make a quality adjustment until you know what your index fam-
ily is. And I'll give you this example. Everybody has got a VCR,
and the BLS didn’t put VCR’s in early enough. Well, if you’re doing


100

would point out on 12 that it, you know, it said it rejected it but
it partially agreed with at least some aspect of the recommendation
according to the information BLS provided us. For the other eight,
excuse me, for the other five for which you don’t see anything in
our columns there, those are ones for which BLS has said it does
have activity under way, or research ongoing, but it did not include
those activities as part of its plan or performance goal, and it’s not
required to, by the way.

Mr. Suays. Right, OK, fair enough. OK, so, but what should I
conclude from that?

Mr. Uncar. Well, [ think that you would conclude a couple of
things. First of all, one of the things you should conclude is that
a stakeholder in BLS’ efforts cannot tell from its strategic plan to
what extent it is addressing Boskin Commission recommendations,
and to what extent it isn’t, or if a linkage is there.

Mr. SHays. Let me just, Dr. Abraham, | think it would be helpful
for the subcommittee, and I've given the time and issues here for
you to outline which recommendations you feel are important to
pursue and which ones you totally discount and reject and we can
have a dialog about that. And I think that would be a good way
to go, and I can leave it at that, unless you want to make some
general comments?

Ms. ABRAHAM. Perhaps, I could with due respect to other panel
members’ desire to conclude the conversation, just make a couple
of quick comments.

Mr. Suays. Sure.

Ms. ABRAHAM. Bob Gordon, in his opening statement, identified
some areas where we hadn’t yet made public comments that he
was aware of. On some of the things he talked about we have made
public commitments to do something and we can specify that to you
in writing. On others, we have ongoing research that is looking into
the issue. Some things, as has already been indicated, we just don’t
agree with. One thing that he talked about was modifying the allo-
cation of our data collection resources to optimize what we're get-
ting out of those resources, and we feel we're doing that already so
we really don’t agree with the recommendation.

I think there also is a separate issue here about the role of our
strategic plan in addressing all of this. Both the Secretary of Labor
and I feel it would not be appropriate to include in our strategic
plan the recommendations of each and every advisory committee,
no matter how distinguished, that might give us advice. What the
strategic plan includes are specific things that we have figured out
we can do and have made a commitment to do. That doesn’t indi-
cate that there aren’t other things that we’re doing. I don’t know
how to put——

Mr. SHays. OK——

Ms. ABRAHAM [continuing]. Research that we’re doing into our
plans and if there’s some different thing that we should be doing
in that regard, we’re open to any thoughts on that.

Mr. Suays. Well, let me just tell you what the request of the sub-
committee would be, and we will follow it up. I think separate from
any strategic plan, performance plan, I would like to know what
items a particular commission, it happens in this case to be the
Boskin Commission, what you, what BLS’ reaction is to those rec-


41

CPI Testimony, House Subcommittee on Human Resources, April 29, 1998, Page 8

per year rather than the 1.1 percent per year suggested by our report.*

Thus far I conclude that the Boskin report conclusions have survived the initial round
of criticism quite well. Our estimate of upper-level substitution bias may have been too low,
and the examples cited by the BLS in which we may have exaggerated quality change bias
are likely ro be outweighed by the sources of understatement cited above — products we
neglected, intangible but undeniable sources of quality change, and our failure to quantify
the value of invention itself, that is, what consumers have gained from the fact that new
products now exist that did not years or decades ago.

Let me now focus on some of our recommendations where the BLS has not yet
committed itself, and make some specific recommendations that could require Congressional
support and funding.

There is no dispute with our first recommendation, that the BLS should attempt to
implement the principle that the CPI is an index of the cost of living, in the theoretical sense
accepted by economists. Indeed Abraham-Greenlees-Moulton (1998, hereafter A-G-M) say
explicitly that "this seems basically right to us" (p. 27), But thus far there has been no
movement on our second and extremely important recommendation, that the BLS should
produce a second index, "research-based," produced only annually with a lag, and subject to
continual revision. The purpose of this second index is to confront the fact of life, that

4. The annual rate of change of the “core” CPI (excluding food and energy) exceeds that of the “core”
PCE deflator (excluding the same items) by an average rate of 0.5 percent per annum during the 12
quarters 1995:Q1 to 1997:Q4. Of our total 1.1 percent bias, the PCE detlator corrects for the 0.15
percent rate of “upper-level” substitution bias and perhaps 0.2 percent of our 0.6 percent adjustment for

quality change and new products. The PCE deflator is still subject to the 0.25 percent rate of lower-level
substitution bias, 0.1 percent of outlet substitution bias, and at least 0.4 percent of quality change bias.