What is the Best Way to Measure Inflation?

By on November 20, 2015 in Current Events, Retirement with 26 Comments

The Social Security Administration states that the goal of a cost-of-living adjustment is to ensure that the purchasing power of seniors is not eroded by inflation, but with no COLA planned for 2016, does that mean that seniors do not have to worry about inflation?

That depends on how you measure inflation. The current formula in the Social Security Act is based on increases in the U.S. Bureau of Labor Statistics’ Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), but that is only one government measure of inflation.

Since the original formula was created in 1975, the federal government has developed a number of inflation measures. These include not only BLS’s CPI-W, but also the Consumer Price Index for All Urban Consumers (CPI-U), Consumer Price Index for All Urban Consumers, Chained (CPI-Chained), Consumer Price Index for Consumers Aged 62 and Older (CPI-E), and the Personal Consumption Expenditure Price Index (PCEPI) produced by the U.S. Bureau of Economic Analysis and currently the inflation measure favored by the Federal Reserve.

While the CPI-W indicates a drop in consumer prices (resulting in no COLA for 2016), the CPI-E, which stands at the other end of the inflation indicators, shows a modest increase for the same time period. If the CPI-E were the basis for the Social Security formula, the average Social Security recipient could expect their benefits to rise by $8.02 per month or more than $96 in 2016.

With nearly 65 million Social Security beneficiaries plus federal retirees, the choice of inflation measure becomes a significant factor in the government’s FY 2016 budget.

Measure of Inflation 12-month percentage change using the formula specified by the Social Security Act
Consumer Price Index for Wage Earners and Clerical Workers (Current Series) (CPI-W) * -0.4%
Consumer Price Index for All Urban Consumers (Current Series) (CPI-Chained) -0.2%
Consumer Price Index for All Urban Consumers (Current Series) (CPI-U) 0.1%
Personal Consumption Expenditure Price Index (Chained-type Price Index) (PCEPI) 0.3%
Consumer Price Index for Consumers Aged 62 and Older (CPI-E) 0.6%

* CPI-W is the index currently specified in the Social Security Act to determine the Social Security COLA.

Using the CPI-E as an inflation indicator does come with caveats, since the index is experimental and unpublished.

For example, the index has a higher sampling error because it is derived from only one-fifth of the households used for the published consumer price indexes. BLS warns that a full sample of seniors might reveal different buying habits.

While all consumer price indexes factor senior discounts into their calculations, BLS suspects that inclusion of these discounts are understated in the experimental index. Since seniors account for only a small part of the full sample, those discounts have a small effect currently, but an index built around senior purchases might reveal a rate of inflation that differs from the current experimental model.

Rather than rely on any automatic formula to adjust benefits, Senator Elizabeth Warren has offered the Seniors and Veterans Emergency (SAVE) Benefits Act, which “will give seniors on Social Security, veterans, those with disabilities and others a one-time payment in 2016 equivalent to an average increase of 3.9% — the same as the taxpayer-subsidized raise that CEOs received last year,” according to the senator.

Social Security recipients, military retirees, and workers who receive Railroad Retirement benefits would get an increase of about $581 in 2016 — a little less than $50 a month. The proposed law does not currently mention payments to federal civilian retirees. Instead, federal retirees would receive a refundable tax credit equal to the same amount.

By requiring Congressional action rather than relying on an automatic formula, the SAVE Benefits Act echoes the law before 1975 when benefit increases were set by legislation and were not automatic.

Determining cost-of-living increases for government benefits remains an essentially political decision even if using an automatic formula gives the appearance of a more scientific approach. Politics remains an important part of the COLA process.

© 2016 Michael Wald. All rights reserved. This article may not be reproduced without express written consent from Michael Wald.

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About the Author

Michael Wald is an independent economics analyst and writer based in the Atlanta area. He specializes in topics related to business, labor, and human resources. Prior to his retirement from the U.S. Department of Labor, he served as the agency’s Southeast Regional Director of Public Affairs and Southeast Regional Economist.

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