We want to thank the New York Times for pointing out in an editorial today (January 13, 2013) that the “chained CPI” is a bad idea.†  As the editorial claimed, this attempt to lower Social Security benefits is based on bad math and bad logic.  Nevertheless, the flawed and unfair notion of suppressing cost of living increases with a “chained CPI,” is not the worst CPI problem facing retirees and workers. The way in which the CPI is calculated now and has been calculated for a considerable time in the past is a much bigger problem.

It is time that we have an honest conversation in this country about the statistically and scientifically flawed – absurdly flawed – methodology for determining the overall increase in the cost of living.  In this discussion, let’s not sugar coat the role of the Bureau of Labor Statistics – the agency responsible for the gargantuan task of measuring changes in prices of literally thousands of goods and services.  Inside the Washington beltway, it is not considered acceptable in polite company and polite conversation to tell the truth about such things as professional wankery on behalf of the rich and powerful.  But we are not in the Washington beltway.

Twelve Month Increase in the Overall Cost of Living: November 2011 to November 2012

The latest BLS report on the change in prices for commodities and services indicates that the overall cost of living between November 2011 and November 2012 rose 1.8%.*  The final report has not been released yet but it will not vary significantly from the most recent release.

If you are a senior on a relatively low, fixed income or a low wage worker, this will come as something of a surprise.  In fact, this news will probably make you angry because you are amongst the folks struggling to pay rapidly increasing inner-city bus fares, rapidly rising costs of child care, health insurance premiums – if you have health insurance at all – rapidly rising water, sewer, and trash pickup services, rapidly rising elementary and secondary tuition and fees, and rapidly rising higher education tuition for training that the power-elite says you need to become competitive in the labor market – to name a few inflationary aspects in the exchange of goods and services in today’s America.

The primary problem is this:  The BLS claims that many items with the largest price increases are not a big part of household budgets – even those household budgets in the lower income strata of society (I doubt if folks in the middle income strata would think the BLS understands their budgets very well either).  Professionals in the agency responsible for a fair measure of price increases can justify this statistically by simply considering overall averages for what surveys indicate is spent by households on a huge variety of goods and services.

Below is percentage price increase of a select set of items and the weight assigned to them by the BLS (the weights are the proportion or percentage of a theoretical household budget – all weights sum to 100):

 Imagine a single mother with one or more children or a senior citizen depending upon Social Security – think of any middle class family.  Does it seem likely that health insurance, school tuition and fees, child care/nursery school, and public utilities such water, sewer and trash collection services comprise only 3.872% of a household budget?  With rent and food, these items made up 49.436% of a household budget, on average, in the year between November 2011 and November 2012 – according to the BLS.

Overall inflation was low for the past year because of such items as energy (.3% increase, 10.184 weight), commodities less food and energy such as new vehicles (1.4% increase, 5.507 weight), household furnishing and supplies (-.1% increase, weight 3.292), food at home (1.8% increase, 14.175 weight) and rent (2.2% increase, weight 31.389).

In the real world, working people struggle with paying rent, accessing health care, paying for child care, school tuition, and food.  If only they would, after meeting all those needs plus others too numerous to mention in this short document, have half of their earning left over for entertainment, vacations, and other pieces of the American pie to which we all aspire.

Things Will be Getting Harder for the Masses

 Most certainly, readers of this bulletin noted the big increases in items related to city services.  As the Federal government cuts taxes and devolves an increasing number of services normally undertaken at the Federal level, local governments will be strapped for funds to provide essential services.  Regressive but increasing state and local user fees and sales taxes will consume ever larger portions of household budgets.

The relatively low increases in energy and food during the past year can be explained by the volatility in these commodities, which fluctuate due to speculation in the commodities markets, weather, and other factors.  It is unlikely that food prices will not spike in the near future.  Drought, an oligopolistic grain commodity industry,  rising demands in developing nations, and other issues will most certainly put upward pressure on food prices in the near future.

Due to a restructured production system in the United States – the shipping of jobs to cheaper labor markets and robotization –  fewer and fewer people have the income to buy new cars, new homes, and other large ticket items. This has created a negative feedback loop – fewer jobs, less income, less demand, and the cycle reiterates.  As worker income drops, government revenue drops, which is also due to the chutzpah of wacky, right wing, libertarian ideologues and their billionaire funders. Increasing costs of state and local government, education, and child care hit the lowest income groups the hardest but it’s not easy on the middle class either.

Artificially Low Inflation Benefits the Power-Elite

 It is not easy to adequately explain the CPI to most people who have little time in their busy lives to read about and think about something as complex as price economics in the largest economic system in the world.  This bulletin certainly doesn’t do justice to the issue.  But we must begin to work at communicating the basics of the BLS system and its unfairness to all but the very affluent.

Much more than suppression of Social Security benefits is at stake.  Measures of such phenomena as poverty and worker income growth are defined and measured in relation to the CPI.  Workers’ wages and salaries are impacted in significant ways by what the BLS publishes as the official CPI.  If the government – at the behest of the power-elite – can create a price change reality to the advantage of the power-elite, employers can much more easily justify stagnant wages/salaries and legislators have an easier time denying increases in the minimum wage.

In this series of posts, more will be written about the cooperation of the BLS with the power-elite in suppressing the CPI.  Evidence abounds that this one agency in charge of fairly and validly calculating prices and their impact on the cost of living is not acting in the peoples’ interest.  Look for several upcoming bulletins in the next few weeks, which will further explain flaws in BLS methodologies and the reason that agency is promoting these flawed practices.

†see: “Misguided Social Security Reform,” New York Times, The Opinion Page, January 13, 2013, page 10

*see report at:  http://www.bls.gov/news.release/pdf/cpi.pdf

My last post – January 9^th – generally explained some of the statistical gimmicks utilized by the Bureau of Labor Statistics to suppress the consumer price index and consequently reduce cost of living increases for a broad array of retirement programs.  Redefining how the CPI is calculated amounts to a cut in benefits for retirees – including veteran retirement, disability, and Social Security.  This is a big deal.  The cuts we are talking about are not small.

According to my fellow activists and good friends Nancy Altman and Eric Kingson of Social Security Works, the decrease resulting from a so-called “chained CPI” will impact Social Security beneficiaries thusly:  the typical beneficiary will lose $500 by age 75, $1,000 by age 85, and $1500 by age 90 (see their Huff Post article at http://www.huffingtonpost.com/eric-kingson/chained-cpi-social-security_b_2376108.html).  Nancy and Eric are both nationally recognized leaders in the field of Social Security.  Nancy has written one of the two leading histories of the Social Security system and is considered one of the three leading contenders for the Social Security Administrator position.  She will be guest on Sharon Lockhart’s KKFI program “Every Woman” at 3:00 PM on Saturday, January 12^th.

This post explains the current methodology for calculating the CPI.  Even without further unfair suppression of cost of living through the chained CPI gimmick, the working classes, poor, and seniors are now losing ground due to unfair and invalid methods for calculating price increases and their impacts on subgroups of the population.

The Current CPI:  Bad Math Foisted on the American Public by Statistical Bullies

I am not approaching the issue of the CPI from the vantage point of a “mainstream economist,” but rather as a statistician. It is obvious to me that the statistical approaches to calculation of the CPI are invalid and seriously disadvantage the elderly, the poor, and to a lesser, but still serious, extent middle income workers. I will explain how certain categories of goods are weighted and how this is one of the major reasons the CPI calculation is unfair to particular groups of Americans.

It seems as though BLS officials and a group of conservative economists have engaged in some “inside the beltway wankery” to snow the public with abstruse “hedonic regression models” and other forms of mathematical dissimulation.  This is in actuality a form of bullying.  Economists and public officials pushing their agenda with patently absurd pseudoscience know that only a very tiny proportion of the population will have the expertise and mathematical wherewithal to counter what seems to them (the public) to be illogical on its face.

People know what they are paying for housing, food, health care, utilities, and a broad array of other goods and services necessary for meeting basic needs.  A large segment of the U.S. population – especially those at the lower income levels – know that their costs of living increased more than the official 1.8% in 2012.

Statistical bullies use abstruse mathematical concepts to foist unfair public policy on the poor and middle income wage/salary classes and seniors.  Manipulating the CPI and keeping it artificially low works to the advantage of the super-rich and mega-corporations, i.e. the power elite. This is a much bigger deal for the economic well-being of the masses than is commonly understood by most people.

This blog post will discuss math that most everyone understands.  What I present below should be devastating to any argument for reducing Social Security benefits through manipulation of the CPI.  This type of material is a real “eye glazer” for most people.  However, as I said, it is a big deal and push back is critical for stopping the economic deterioration of the middle and low income classes and retirees.  Please let me know if you have any questions in the comments sections below.

The Market Basket & the Weight Given to Categories of Goods & Services by the BLS

For the most part, the BLS determines prices of goods and services through a massive data collection process (mainly through a survey of businesses).  Prices are collected on thousands of goods and services, which are grouped into categories such as “food,” “energy,” “apparel,” “shelter,” “medical care services,” “transportation services,” and “education” – to name a few.

Within each of these general categories are more specific goods and services.  For instance, within “transportation service,” one will find public transportation, within which one will find “intercity bus fare.” Each category is assigned a weight.  All weights must sum to 100.  For instance, food is weighted 14.175; energy is weighted 10.184.  The weight for “medical care services” is 5.387.  These weights also provide a clear idea of what the BLS thinks is the proportion of each good or service in a consumer’s budget.

As already mentioned, the BLS calculation of the overall increase in consumer prices between November 2011 and November 2012 was 1.8%.  Also, as already discussed, not all items in the market basket contributed equally to this “overall” increase in the CPI.  Here’s how it works:

“Medical care services” are weighted by the BLS at 5.378, which is .05378 or 5.378% of the total.  Health care services increased 3.7%.  The contribution of this 3.7% increase to the overall increase is (.05378 * 3.7)/1.8 = .12 or 12% of the overall increase.

How were the 5.378 weight and 3.7% increase in medical care services derived?  Within medical care services one will find three major subcategories: “professional services,” “hospital and related services,” and “health insurance,” weighted 2.987, 1.749, and .651 respectively.  These weightings sum to the overall weight for medical care services of 5.378.  The percentage price increases were as follows: professional services = 2.0, hospital and related services = 4.4, and health insurance = 11.2.

The 3.7% increase in medical services is derived as follows:

[(2.987/5.378) * 2.0] + [(1.749/5.378) * 4.2] + [(.651/5.378) * 11.2] = 3.7.

The problem with this methodology is this:  different subsets of a population have very different budgets, which do not reflect the BLS market basket based on an aggregated total.  A senior on Medicare must spend $300 per month on premiums for Part B, Medigap, and Part D or have co-pays and deductibles. The increase in the Part B deductible from Social Security checks has been practically double the rate of inflation for the past 10 years.  Furthermore, as discussed next in this post, some of the commodities and services such as city services, public transportation, child care, tuition, and others that have had the highest percentage increases are weighted low by the BLS but loom large in the budgets of the working classes and seniors.

Why Is the BLS CPI So Low When You Feel So Much Pain From Price Increases?

The low CPI of 1.8% for the past year was low for four reasons:

1. The BLS weights categories based on the ratio of purchases in each category to the quantity of purchases overall.  For instance, energy purchases accounted for 10.184% of all purchases but had a low percentage annual increase of .3 or three tenths of 1%
2. Goods and services with the highest percentage increases had the lowest weightings.  For instance, health insurance increased by 11% – the highest of any category (it is actually a subcategory of “medical care services) – but has been assigned a weight of .651% by the BLS.
3. The weights assigned to each category are based on aggregated data and do not consider subsets of the population.  A poor person’s budget (as well as a senior citizen’s on a fixed income) will reflect far different proportions (weights) for high percentage increase items such as bus fare, tuition, child care, and city services (sewer, water, and trash pickup).
4. In a down economy – which we have had in the past year – sales of apparel items, new vehicles, appliances, and other commodities are slow.  Retail outlets will be more likely to move these commodities through sales and other mechanisms for keeping prices low.Indeed prices for transportation commodities (less motor fuel) increased only .1% or one-tenth of one percent.  These mostly big ticket items are not as likely to be in the market basket of poorer Americans and retirees dependent upon Social Security.  And yet, these commodities comprise approximately 20% of the market basket weights.

Consider the following market basket categories:  “water, sewer, and trash collection,” “intercity bus fare,” “elementary and high school tuition & fees,” and “child care and nursery school,” which had price increases of 6.9%, 4.8%, 3.5%, and 2.6% respectively.  Along with medical care and health insurance mentioned above, these expenditures have a major impact on working family and retiree budgets.  However, they are weighted 1.187% (“water, sewer, and trash collection), .147% (intercity bus fare), .368% (tuition & fees), and .386% (child care).

Summary

The explanation of the CPI in this post focuses on only one facet of mathematical problems with calculation of the overall increase in prices.  However, the weighting of various commodities and services is a much bigger cause of unfairness of the CPI relative to poorer people and retirees on fairly low fixed incomes than the current brouhaha over the chained CPI – although that is a serious problem.

I was inspired to begin a discussion and explanation of the CPI by members of Jobs & Justice – a progressive activist group comprised of economic faculty, labor leaders, business persons, and other activists who have joined together to develop a strategy for economic justice.  At a meeting the other night, members of the group discussed a need for helping the public understand what the BLS methodologies are doing to their economic well-being.

Hopefully, this post will provide some clarity to the issue.  It is not easy to reduce the CPI to a short post.  The Tallgrass Activist will continue to explicate the basics of the CPI and their implications for working families and retirees.

*CPI data referenced in this post can be found at http://www.bls.gov/news.release/pdf/cpi.pdf

Right-wing and anti-Social Security forces in the U.S. have been successful in suppressing retiree benefits, workers’ wages/salaries, and programs indexed to the consumer price index (CPI).  Because of many techniques for suppressing the official measure of the CPI –advanced by conservative economists over the past few decades – middle and low income wage/salary earners and retirees have lost ground to the cost of living.

One of the gimmicks now offered by conservative economists, politicians, bureaucrats, and pundits, is known as the “chained CPI.”  What is the “chained CPI?”  This bulletin will “boil it down” and provide a catalyst for a wider discussion of this misguided notion.  In general, it must be said that in the history of big pseudo-scientific ideas, the chained CPI ranks right up there with the homunculus, Piltdown Man, the free market, the bleeding of patients with leeches, eugenics, and Lysenko genetics.

The chained CPI and its underlying justification by the Bureau of Labor Statistics (BLS) through a subset of assumptions about human behavior are little more than cynical attempts at manipulation of the CPI to the detriment of workers and retirees and to the advantage of corporations and the super-rich.  This bulletin will cover three concepts essential to the chained CPI construct: (1) “substitution bias,” (2) the “hedonic adjustment,” and (3) the geometric mean versus the arithmetic mean.

Any lay person with no more than a basic knowledge of high school math can understand these concepts and no one should be intimidated by them.  Trust me; the chained CPI is the invalid reduction of the inordinately complex dynamics of consumer behavior and price fluctuations in the world’s largest economic system to a few simple mathematical models (the U.S. officially has a GDP of nearly $16 trillion or $16,000 billion).  In the world of science, this fallacy is known as reductionism.  You will see that fallacy clarified as you read on.

Let’s look at the three concepts underlying the chained CPI construct:

Substitution Bias

Substitution bias simply means this:  when prices rise on a staple or service regularly purchased or needed by an individual or group of individuals, the individual or group of individuals will substitute a cheaper product or service for what was regularly purchased or would be purchased; ipso facto, when prices rise, the cost of living actually declines.  For instance, if you are accustomed to buying steak and the price of steak increases, you are compelled to purchase ground round; therefore, your cost of living has actually gone down.

Believe it or not, that is the theory.  That’s pretty much all there is to it.  Even though it doesn’t pass the laugh test, economists have been all too eager to come forward with complex “econometric models” to overlay this nonsense with a patina of science and mathematical validity.  As a statistics professor, I can tell you that these models are of no higher quality, i.e. statistical validity, than the nonsensical assumptions on which they are based.

Hedonic Adjustment

Do you think that higher prices for goods and services imply that you have a much better product than you had at a lower price, and therefore your cost of living actually decreases because of all of the bells and whistles on the ever expanding array of the gewgaws, electrical devices, apparel, etc. that are offered up to consumers these days?  Have you looked at the charges on your phone bill lately?  Were they there in 1950, 1960, 1970, 1980, or even 1990?

It is this notion that has led the BLS to lower the CPI in recent years in spite of so many increases in the prices of necessities without a correlative increase in quality.  What are students and families paying for education these days versus the 1960s or even much later than that?  What does your health insurance cover these days for the price increases you have seen?  OK.  Enough of this – we could go on and on about the absurdity of this notion.

Geometric Mean Versus the Arithmetic Mean

Considering that the CPI involves a survey of thousands of products in a “market basket” of goods and services, calculating averages is a major mathematical technique for arriving at changes in prices.  There is more than one method for calculating an average.  For instance, by middle school, practically all numerically literate people have a good handle on the arithmetic average.  Unfortunately, only mathematicians/statisticians have exposure to the other types of “means.”  For instance, the “geometric mean” – applied now by the BLS in calculation of the CPI – is calculated by taking the product of all values in a dataset rather than summing all of the values.

Here is an example of an arithmetic mean versus a geometric mean:  three people ages 19, 20, and 21 would have an average age of exactly 20, i.e. (19 + 20 + 21)/3 = 20.  A geometric mean would be the cube root of 19 * 20 * 21 = 19.98331943.  The geometric mean in this case is ever so slightly lower than the arithmetic mean.  Three issues are important here: (1) very small reductions in the CPI due to mathematic gimmicks are compounded over time and result in major losses of benefits and wages, (2) as the number of values and variance of the distributions of values entered into the calculation of the geometric mean, divergences of the geometric mean and the arithmetic mean increases, and (3) the CPI has been suppressed by about ½ of 1 percent each year by this technique throughout the past decade (thinks to the Boskin Commission in 1996, which is a subject for a later bulletin).

Summary

No valid, credible, empirical/scientific evidence exists to support substitution bias and quality improvement, which have resulted in the hedonic adjustments, lower CPIs, and, consequently, a call for aneven more conservative CPI known as the chained CPI. Nevertheless, the BLS, an agency responsible for fairness and economic justice involved with the determination of price increases and charged with looking out for the well-being of all U.S. citizens in adjustments in the CPI, has decided to apply a mathematical gimmick in repressing benefits, wages, and salaries.  They are, in fact, making life more difficult for the broad mass of working people and retirees.

No doubt, tracking changes in in prices of goods and services within the U.S. economic system is a massive and complex undertaking.  Nevertheless, we expect more than overly-simple models, the origins of which can be traced to conservative think tanks and the results of which advantage the wealthy and penalize the masses.

It is important that we call out the stewards of our economic well-being and demand that we have an open and honest explication of reasons for suppressed wages and benefits along with discussion of poor and middle class quality of life and how it has changed due to the disappearance of masses of good paying employment and major increases in necessities of life – including education, health care, and housing.

Officially, the CPI has increased at an average of 2.1% from 2000 through 2011.  Even considering the negative -.34 CPI change in 2009, it would seem as though 2.1% is an unbelievably low average increase in the CPI over the first decade of the current millennium.  Enough is enough.  We expect fairness and will demand it.