Mr. Chairman and Members of the Subcommittee: I am 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. 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. 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 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. 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. 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 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. 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 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. 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 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. obtaining funds to bring about change to the CPI and concern 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 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. 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.