In response to:
The Cost of Living: A New Myth from the March 6, 1997 issue
To the Editors:
As the two Commission members most responsible for the treatment of quality change in the report of the Advisory Commission on the Consumer Price Index (hereafter Advisory Commission on the CPI Report, or ACCR), we are writing to defend the report against the recent attack by Jeff Madrick [“The Cost of Living: A New Myth,”NYR, March 6]. Madrick damns the ACCR for three major sins—that its treatment of quality change and new products is “subjective” and “speculative”; that it “largely ignores” the adjustments for quality change already made in the CPI; and that quality change may not be much valued by the poorer consumer. The tone of Madrick’s review is suspicious of any effort that tries to improve our knowledge of price measurement, which is a central ingredient in every national statistic about productivity, real wages, and economic progress in general. His review looks for ulterior motives and focuses on imperfections, without giving credit for the honest attempt to provide an answer, imperfect as it may be, to these important economic questions.
Madrick supports his diagnosis of subjectivity by quoting one of us as calling the ACCR’s numbers “squishy.” Had Madrick used the whole quotation by Griliches, it might have set a more neutral tone for his review of the Commission’s work. The complete quotation said, “Such values are not chiseled in stone. They are squishy numbers but they are better than a firm but wrong zero” (The New York Times, December 16, 1996). The reference to “zero” refers to past evaluations, which simply assume (subjectively) that the CPI bias is zero in all categories except those which have been subject to careful review. In contrast, the ACCR extrapolates research on bias from one category to another when the categories seem related. To assume a zero bias in those categories not subject to careful research represents an extreme one-sided answer to the question as to whether those components of the CPI are biased. “They may be as likely to be subject to the average rate of bias of those components which have been subject to careful research as to no bias at all.”
Madrick chides the Commission for doing “little original research and much of the evidence it cites is old or covers only limited periods of time.” The Commission was not given a budget or a time frame suitable for doing major original research. We agree with everyone else that more research is desirable. However, we did cite all the previous research that we could find, and we reject an implication that our citation of previous research was selective. Indeed, some of the research is “old,” based on Gordon’s book which ends its coverage in 1983, but that research covers thirty-seven years, not a “limited period of time.” Other research, particularly that on apparel, personal computers, cataract and heart surgery, and pharmaceuticals, has been completed within the last few years.
Much of Madrick’s skepticism about our valuation of quality change and new products is based on recent research by Brent Moulton, director of research at the Bureau of Labor Statistics (hereafter BLS), partly in collaboration with Karin Smedley. A paper by Moulton and Smedley (M-S) and a discussant’s comment by one of us (Gordon) is forthcoming shortly in the Brookings Papers on Economic Activity and helps to clarify this controversy. To quantify what is at stake, the ACCR estimate of quality change and new product bias is 0.61 percent annually for the 1995-1996 period. Of this, 0.31 percent comes from appliances, radio, TV, personal computers, drugs, and medical care, all of which M-S accept at face value. M-S argue persuasively that our estimates for fruits, vegetables, shelter, and motor fuel are overstated, but replacing our estimates by theirs for these categories together only eliminates 0.11 points of our 0.61. In two other categories, we are not convinced that our estimates are too high. For apparel our alternative index is based on prices from the Sears catalog for a period when Sears was losing market share to other outlets offering superior prices and quality, and for automobiles any overstatement of the value of increased durability may be offset by the well-documented decline in defects of new automobiles and the reduced frequency of repairs, as documented by the J.D. Power survey, Consumer Reports, and other sources.
Even though, as Madrick and M-S argue, it may turn out that some of our estimates of quality change in particular items may be too high, others are likely to be too low. There are at least three sources of understatement in our estimates of quality change and new product bias. First, we did not take into account numerous but undeniable aspects of quality change—including (as stated above) reduced initial defects and repair frequency on new automobiles; improved sound quality, picture quality, and reliability of audio and video equipment; improved materials that reduce weight and corrosion in a host of consumer durable goods; improved safety of home power tools, lawn mowers, and other products; and improved energy efficiency of a wide variety of consumer goods.
Second, we did not take into account the value of the consumer surplus from the invention of new products. Among the evident benefits of inventions which we ignored are the value to consumers of being able to watch videos at home without spending money on babysitters and parking; the value of microwave ovens in making possible quick and convenient hot meals at home; the value of central air conditioning in opening up the possibility of living in inhospitable climates; the value of the ATM in making cash available at all hours in many new locations; not to mention the value of modern diagnostic and operative techniques in reducing the pain of medical procedures, and in converting previous procedures requiring inpatient hospital stays to simple procedures done on an outpatient basis. While some of these benefits of new products are hard to quantify, and we did not try, Hausman’s imaginative recent treatment of the value of cellular phones shows what can be done; he concludes that the CPI for telephone services is upward biased by 2.3 percent per year, compared to a bias estimate of 1.0 percent in the ACCR.
Third, we did not take into account evidence emerging from recent research that finds rates of upward bias in the CPI substantially greater than that incorporated into the ACCR. For instance, Gordon finds recently (see in the above-referenced exchange with M-S) that the CPI for television sets is upward biased by 8 percent per year, as contrasted to the 3.3 percent per year assumed by our report. Even more important, the Commerce Department publishes an alternative estimate of consumer price inflation (the deflator for personal consumption expenditures) that rose fully 0.7 percent slower than the CPI during 1995 and 1996; it is based on alternative and most think superior price indexes for computers, medical care, and airline fares, and some of these alternative indexes are compiled by the BLS itself.
In addition to questioning our estimates of the CPI’s quality-change bias, Madrick’s second main point is that the BLS already does extensive qualitative adjustments and that therefore our adjustments must be double-counting some of it. His argument leans heavily on the unpublished work of Moulton and Smedley, who estimated, at the time, that the BLS made adjustments that reduced the inflation rate in the CPI by about 2.6 percent in 1995. In the meantime, in their revised version (March 1997), the number has shrunk to 1.76. Excluding “outliers,” commodity pairs where the implicit price-quality differential exceeds 100 percent (which are simply noncomparable pairs and are not likely to reflect what either the BLS or we had in mind by the concept of “quality change”), the number shrinks to a mere 0.3 percent. At this point, the argument loses any quantitative significance.
We could leave it at that, but it is still instructive to discuss it, since it illustrates the substantive and communication difficulties in this field. Most of the reported “quality adjustment” by the BLS, 1.65 out of the 1.76 percent that includes outliers, comes from “linking” procedures, where a missing item is replaced by another. No judgment at all is made about the quality differential between the new and old item. The price change during the link period is imputed, by using either the inflation rate in the overall CPI or of other commodities in the particular class. These adjustments are the consequences of the BLS sampling procedures, which focus on pricing a very specific item in a particular store and city. There are thousands upon thousands of such commodities in the market but only a small fraction of them are in a particular store at any time. The pricing agent has to deal with rapid turnover and high probability of stockout. Roughly one out of two items disappear sometime during the year and have to be replaced by a different item in the same general class: a larger versus a smaller package of yogurt, a blue raincoat versus black, a refrigerator with its freezer at the bottom rather than at the top. But this churning is not what we had in mind by “quality change,” which rather involves the appearance of new and improved goods, such as the increased variety and freshness of vegetables and fish due to the improving transport facilities and the globalization of trade, the substitution of laporascopic procedures for gallstone operations, and more.
The fundamental point, which Madrick ignores, is that for most categories the extent of current BLS quality adjustments is irrelevant, because most of our estimates of quality-change bias are valid independently of how the BLS arrives at its estimates of price change, and the extent to which its own quality-change adjustments are large or small. Most of our bias estimates are based on the collection of price data from independent sources and the careful quality adjustment of those independent data. The difference between these quality-adjusted independent price indexes and the corresponding CPI indexes (however they are quality adjusted, in a major or minor way) forms the basis of by far the majority of our estimates of bias.
Madrick’s third objection is that our recommendations are unfair to the poor and the elderly. Life is unfair to the disadvantaged members of society, but this has little to do with the CPI, which is a measure of prices paid by the average, unaging household, in an unchanging socioeconomic environment. Some of the poor (whether elderly or not) should be provided with a better safety net, but the CPI is only intended to measure changes in the average price level, not the special circumstances of particular groups.
The real issues involved with the special circumstances of the elderly involve health costs, which rise with age and with some improvements in medical technology. These are real drains on the budgets of the elderly, and indeed on all of us. A true cost-of-living index measures the change in income required to maintain a given standard of living for a person or household of a given age. The opportunity provided to live longer by improved albeit more expensive medical technology represents an increase in the standard of living, not an increase in the cost of living.
Madrick’s complaints about how people “feel” when they do not own the fruits of modern life confuse the relative standard of living with the absolute standard of living that a cost-of-living index attempts to measure. The CPI has always been intended to provide a single number for the average rate of inflation, not any information on changes in the the distribution of income. Indeed, changes in the income shares of the bottom 20 percent versus the top 20 percent can be assessed with measures of actual dollar income and do not require any inflation adjustment, i.e., no use of the CPI at all.
Madrick claims that today’s quality improvements are “skewed towards higher-income workers.” He may not be aware that 98 percent of American households own an average of 2.2 color TV sets, and 78 percent own at least one VCR. Further contradicting his position, a recent report compiled by the Employment Policy Foundation compared the ownership of particular household goods in 1970 by the average American household and in 1993 by the poorest 20 percent of households. In 10 out of 13 categories, the poorest in 1993 were better off than the average in 1970.
There are deeper issues which Madrick does not address. The CPI is useful for indexation of Social Security and other benefits only if there are gainers from inflation who could be taxed to compensate the losers. But many changes in prices occur in contexts where there are no gainers who could be justly taxed. When OPEC raises energy prices, or when AIDS appears, we all become poorer. The elderly should not be protected from such increases in energy costs or health-care costs at the expense of working taxpayers, since society as a whole has suffered a loss. One of us (Griliches) has previously suggested that it would be much more sensible to index benefits by the after-tax median wage instead of the CPI. This would have the great advantage that the elderly would benefit from increases in real wages made possible by productivity advances but would also share in the sacrifice required by higher energy prices or the appearance of AIDS.
Madrick questions our assessments of improvements in quality as “lacking in historical perspective.” Indeed, both of us have written independently in agreement with Madrick’s suggestion that recent new products may pale in fundamental importance compared to earlier inventions going back to the electric motor, internal combustion engine, and Pasteur’s germ theory. But that point is irrelevant to the assigned task of our Commission, which was to assess the bias in the CPI right now, in 1995-1996. There are many reasons to think that the upward bias in the CPI fifty years ago could have been either less or more than right now, but it was beyond the scope of our assignment to carry out that historical assessment.
To conclude, our verdict that the CPI overstates inflation is not a “myth.” As Madrick himself recognizes, several of our recommendations are uncontroversial. Everyone admits that there is a substantial substitution bias, and indeed the BLS is now releasing an “experimental index” that fixes the most important source of such bias (Madrick: “This is the best-documented of the Commission’s claims”). Everyone knows that consumers are flocking to discount stores like Wal-Mart and “category killers” like Home Depot, yet the lower prices and greater variety available at these efficiently managed outlets are ignored by the CPI, and we made a very conservative estimate (1 percent per decade) of the value of these unmeasured price reductions.
As for quality change, in principle both the BLS and the Commission are right. The BLS indeed does make many adjustments, because it has to find some way of dealing with missing items, but its procedures by and large do not constitute explicit comparisons of the actual “quality” of one model of a good to another, but rather simply to impute the price change of a missing item to other related items that are available. Virtually none of this type of adjustment is double-counted in the Commission report.
In contrast, our findings on quality change are based on all the available research conducted by outside academic experts and by the BLS itself. Some of our adjustments may turn out to be too high, but others are surely too low. In any case, we did not claim excess precision for our estimates, as could be seen from the ranges of possible error assigned by us to them. But the fact that the size of some of them is disputable does not detract from our main point, that current procedures miss a significant fraction of the contribution of new and improved goods and services to the advance in the average standard of living.
Robert J. Gordon
Stanley G. Harris Professor in the Social
Paul M. Warburg Professor of Economics
Jeff Madrick replies:
In my article I of course in no way expressed suspicion of all attempts to understand the Consumer Price Index better, as my discussion of the recent work of BLS researchers and several other economists should have made clear. I wrote that “further study of the entire question of living costs is required.” What I am suspicious of is the rush to judgment based on an often one-sided interpretation of partial and often controversial evidence. In fact, the letter from two of the Commission members, in which they openly admit some of their errors and the tenuous nature of the research, far better reflects the complexity of the issues than does the original Boskin Commission report. If the report itself had been more frank about these difficulties, readers, including those on Capitol Hill, would have understood immediately that its conclusions were subject to serious debate.
Contrary to what the authors of the letter write, it should be noted at the outset that the Boskin Commission did not merely adjust those categories of goods and services for quality improvements that the BLS ignores. Rather, the Commission report claimed that adjustments for quality improvement already made by the BLS in several major categories, such as autos and shelter, were significantly understated. Further, when it did propose adjustments to the CPI in categories that the BLS does not directly analyze, these estimates were typically very generous, especially when we consider that in almost all cases they were based on little analysis or evidence. Finally, if the Commission had truly done its work in an objective spirit of inquiry, it would surely have made an attempt to analyze the degree to which deteriorating quality is not measured by the BLS. To the extent that this is the case, the CPI would be too low rather than too high. But the Boskin Commission did not directly analyze any such issues.
In fact, the writers of the letter, who imply that they have answered all my main points, completely ignore my statement that the most disturbing omission in their report was any mention of the deterioration in quality caused by, for example, widely reduced retail service, high crime rates, overcrowded airlines, traffic congestion, and the increased complexity of financial products. The BLS Commissioner has also publicly expressed concern about this omission.
This is not to say that the Boskin Commission’s recommendations are all without merit. But the implication that the report was a neutral and even cautious analysis of possible overstatement of the CPI is not justified. Its main conclusion is that the CPI is too high by 1.1 percent within a range of .8 to 1.6 percent. In other words, the CPI rose by only 2.2 percent rather than the reported 3.3 percent in 1996. The Commission claimed that .6 percent of the 1.1 percent overstatement was due to improvements in product quality. The BLS adjusts for quality improvements because the consumer is getting more well-being for every dollar spent. The Commission also said the CPI was overstated by an additional .4 percent because of the unmeasured effects when consumers substitute cheaper goods for more expensive ones. Another .1 percent of the overstatement is said to be due to the proliferation of discount stores. There are strong arguments that each of these estimates by the Commission are seriously high.
In their letter, Robert Gordon and Zvi Griliches cite the new and important study by BLS economists Brent Moulton and Karen Smedley, which questions many of the Boskin Commission contentions about the effects of unmeasured quality improvements on the CPI. On the basis of the analysis by Moulton and Smedley of such products as fruit, vegetables, and housing, Gordon and Griliches now admit that .11 percent of their original .61 percent estimate of CPI overstatement due to quality improvement is incorrect. But this is by no means the whole story. The authors say that they do not accept the contentions of the BLS that they have made serious errors in their analyses of two other major areas, apparel and autos. But their one-sentence explanation does not directly answer the points made by BLS staff members. Neither does Robert Gordon’s reply to the paper by Moulton and Smedley that is to appear in the Brookings Papers and is alluded to in the letter. For example, Gordon merely reasserts that defects are lower for autos in recent years, providing no further analysis whether BLS quality adjustments already take this into account, as some think they do. I have no doubt that most observers would find that the BLS has made the stronger case in these matters. This comes to another .1 percent or so of the CPI. We are now up to about .2 percent.
The authors state that Moulton and Smedley “accept at face value” the .31 percent adjustment proposed by the Commission for appliances, electronics, and medical services. This is an outright misstatement. The BLS accepts that there are underestimates of quality improvement in these areas, but it certainly doesn’t accept that they amount to .31 percent of the CPI. Moulton and Smedley anticipate that the BLS will soon improve quality estimates for appliances and consumer electronics and that, while research is under way in medical care, careful adjustments in this category will require more time. But they make it unmistakably clear that they do not accept a .31 percent estimate at this time. If Gordon and Griliches want to know why one might be suspicious of their assertions, this mischaracterization is certainly a good example.
Gordon and Griliches also ignore the claims by Moulton and Smedley that the current adjustment made for housing might actually understate rather than overstate inflation. (Gordon does at least raise the issue in his reply to be published in the Brookings paper, but he says he is waiting for more results.) The BLS also says that its “linking method” may systematically over-adjust for quality, and therefore understate the CPI. The linking method reduces the CPI for what is presumed to be the improved quality of substitute products that are brought into the BLS sample mix to replace products that have been discontinued. I will return to this issue, but this over-adjustment for quality could easily come to .1 percent or .2 percent of the CPI and at least one economist thinks it could come to significantly more.1 In addition, a good case can be made that the current BLS adjustment for rising auto quality is already too great, which would also understate the CPI. The total of these adjustments equal .3 or .4 percent of CPI, and maybe more, offsetting most and perhaps all of the .61 percent quality adjustment proposed by the Commission. This does not include any upward adjustment of the CPI due to quality deterioration and whatever exaggeration there may be in the .31 percent adjustment recommended by the Commission for appliances and medical care.
As for the overstatement of the CPI that allegedly results from purchases at discount outlets, the Commission again may exaggerate its claims. The BLS has assumed that no adjustment for lower prices was necessary in the past because shopping at these stores requires more time and effort for consumers, which means reduced quality of services. The BLS may yet agree that some adjustment is warranted. But in an earlier paper on the subject, Brent Moulton had noted that it would take especially low discount prices at these stores and a great deal of volume to justify a reduction of the CPI by .1 percent. What is now known about some product categories suggests discounts are not great enough, though evidence is far from complete.2 Gordon and Griliches merely assert with no substantiation that the Commission recommendation is “very conservative.” Any adjustment for discount outlets that was based on current evidence would probably be considerably less than the .1 percent proposed by the Commission.
Concerning the Commission’s technical recommendations to adjust for consumer substitution of one item for another as prices change, the authors do not bring up the subject in the letter. But in his forthcoming reply to Moulton and Smedley in the Brookings Papers, Gordon writes that the .4 percent estimate has been widely accepted. This is certainly not true of the BLS. The agency believes the .4 percent estimate is at most the upper limit of potential technical changes that will range between .15 percent and .4 percent.
As can be seen, the 1.1 percent estimate of the Boskin Commission is reduced rapidly when subjected to closer analysis. To emphasize the tenuous basis of the Commission’s research, I should summarize the recent findings of the BLS experts. Of the twenty-seven categories of goods and services it analyzed, the Commission asserts that inflation is overstated because of unmeasured improvements in quality in nineteen of them. In nine of these nineteen categories, the BLS experts point out that no evidence or detailed analysis is presented at all. In another six categories, including health care, evidence for only a few items is used to draw sometimes dramatic conclusions for the entire category. In only four categories—new and used autos, housing, and apparel—does the Commission submit either modestly original research or describe its analysis in detail. Concerning these, Moulton and Smedley maintain that the Commission has made serious errors.
The main defense offered in the letter from Gordon and Griliches is that, while errors of judgment may have been made, the Commission left out much information in its original report. If what is omitted is now taken into account, they say, it would show that the CPI is significantly overstated, even given other qualifications. I am at a loss to understand why the Boskin Commission report did not account for these unmentioned items in an undertaking that was supposed to be comprehensive and technically competent. It did not even summarize these items, as the authors have now partly done in their letter. If the Commission had listed these areas of concern, however, they would have been subject to the same scrutiny as their other contentions, and much may again have been found wanting.
Take the assertion in the letter about the “consumer surplus” derived from new products such as home videos. The authors assume renting a video is a substitution for far more expensive outings to the local movie theater. In fact, video rentals are much more likely a substitution for watching free TV—or perhaps reading a book or just sitting around the table chatting with the family. If video rentals were a significant substitute for movie-going, the huge volume of rentals surely would have made a serious dent in movie admissions, but it hasn’t. Instead, the number of movies shown on free TV, for which videos are probably a substitute, has dropped sharply. For most families, video rentals are probably an increased expense, not a savings.
Current research does not tell us how significant these factors are, including the much-discussed “consumer surplus”—or, generally speaking, the added benefit from the invention of new products. But to put the possible effects in perspective, the most frequently cited example of a product whose consumer surplus is not included in the CPI is the cellular phone. This is the example that would have by far the largest impact on the CPI. The authors allude to an “imaginative” academic study of its potential effects.3 But others are skeptical of the study’s results, partly because it does not distinguish between business and personal use of the cell phone. (The CPI is for consumers, not business.) Extrapolating from the study, Moulton and Smedley find that the effect on the CPI would amount to only 0.02 percent of the CPI per year (and this may be high). This is not inconsequential, but most of the other excluded items cited by Gordon and Griliches would probably have a lesser effect, if any at all.
One would have thought that at this point in their letter the authors would have discussed examples of deteriorating quality that the BLS did not take into account, if only to discount them. But, as noted, they do not mention this issue anywhere. Yet it is widely reported that retail services have declined in quality, as has service on airlines. Crime rates have made it necessary to buy expensive safety devices for the home and car. Many financial products require more time and knowledge to analyze. The quality of education has deteriorated. A polluted environment has contributed to higher health costs. The waiting time on computerized telephone exchanges has increased. Traffic jams throughout the nation have reduced the value of cars. Public transportation has deteriorated. Dealing with one’s medical insurance is more complex and time-consuming. Any unmeasured deterioration of quality would bias the CPI in exactly the opposite direction the Boskin Commission reports.
The authors make much of an alternative measure of consumer inflation computed by the Commerce Department that is .7 percent lower than the CPI in 1995 and 1996. But the causes of this discrepancy have almost nothing to do with the quality factors they discuss. The principal cause is that the Commerce Department statistics include medical costs paid by employers and the government, while the CPI only includes out-of-pocket costs of individuals. Such medical cost inflation has fallen in recent years. In the past, however, when medical costs soared, the Commerce Department figure would have been higher in comparison to the CPI. As the writers well know, the two sets of inflation statistics differ only by .2 percent over a longer period of time, about equal to the technical considerations that I agree require appropriate adjustments to the CPI.
As for the quality bias already accounted for by the BLS through the linking method, the authors say I ignored the point that their quality adjustments are of a different type than those already made by the agency. What do the authors make, then, of the following sentence in my review? “The Commission says that the improvements in quality it is discussing are for the most part above and beyond what the BLS takes into account.” But this is not the main issue. The quality adjustments sought by the Boskin Commission typically don’t hold up on their own merits to the extent they claim.
Nevertheless, the BLS has reduced the estimate of the quality adjustment that is owing to linking and related methods and it has provided greater detail about how that adjustment is computed. This is a complex subject that the authors of the letter have interpreted from their own point of view. The controversy is over the substitute products in the linking process that cost twice as much, or more, than the products that they are replacing. The authors assume that all such “outliers” are not genuine substitutes; so reducing the CPI for the price increase should not be thought of as a quality adjustment. But in some cases, notably apparel, such sharp price increases can reflect higher quality of a substitute product—say, far better material in a coat. Some of these “outliers,” then, should be included as quality adjustment. A more reasonable analysis would place the quality adjustment closer to 1 percent rather than the .3 percent cited by Gordon and Griliches.
But the important question about the current BLS linking method is whether it may overadjust the raw inflation data and therefore understate inflation. A good case can be made that it does. An extraordinary number of products are discontinued each year, and there is nothing left to buy in their place but more expensive versions, often higher priced simply because they are new. Or, a substitute product may be changed marginally but the price increased significantly. For example, a cable network might offer a food channel and raise the price of the overall service by much more than the cost of the new channel to the network and more than the usual cost of a new channel to the consumer. The current BLS procedure usually assumes that such increases in price are due to improved quality, and therefore should not be included in inflation. But if this more expensive product is the only option left for the consumer, and if it isn’t a significantly better product, simply a newer one, then inflation has risen by that amount. This is why several economists believe the linking method may significantly understate real consumer inflation.
The authors do not consider this counterargument. They do not even request more research into these procedures, which could clarify the issue. Nor do they allow for the fact that the so-called “churning” of products in the sample does incorporate new products into the system, about which they are so critical. There may well be some overlap between the quality adjustments made through this method and those the Commission is talking about.
A related but important issue the Boskin Commission ignored is the loss of old products on the market that many consumers would like to have back. We might call this a consumer “deficit,” in contrast to the consumer surplus that the authors make so much of. These products might include a basic auto like the old VW. Or more sports on free TV rather than on cable. (In New York, you couldn’t watch the Yankees on free TV this spring.) If you must buy a much higher priced car or a fancy computer or subscribe to cable TV because there is no cheaper, simpler alternative available, then you can reasonably be said to be experiencing inflation. The CPI is not adjusted up for this.
As for the poor, let me reiterate that the Boskin Commission’s recommendations are indeed unfair to this group because the Commission quality adjustments are partly based on products poor people don’t often buy. Of course, there is commonality among what we own. The question is how much commonality there is among the products the Commission says now account for so much quality improvement and increasing consumer well-being. Most people own TVs and VCRs; but most don’t own PCs, subscribe to HBO, use cell phones, or buy four-wheel-drive Jeeps. Forty percent or so don’t subscribe to cable TV. The so-called consumer surplus is largely the province of the better-off, as are many of the fancy new medical procedures the Boskin Commission writes glowingly about, on the basis I should add of little firm evidence. In sum, the Boskin Commission’s recommendations concerning quality are skewed toward the better-off, despite the sarcastic remarks of the authors. Nor can this imbalance be argued away by claiming it is a matter of the distribution of income. Ideally, there should be different sets of inflation statistics for different groups. But it is well to keep in mind that the recommendations of the Boskin Commission, by lowering the level of the CPI, would directly reduce programs for the poor.
The authors trivialize the question of status as a factor determining the standard of living by implying that what people “feel” doesn’t matter in computing a cost of living. This disregards a vast literature on the subject from sociologists, political scientists, psychologists, historians, and even a few economists. Whether or not the CPI should take status into consideration is an open question. What the authors ignore completely is my point about what happens when the new and improved products for which they want to adjust the CPI downward become necessities in dealing with modern life. Acquiring these goods often no longer results in an increase in the standard of living but merely an increased expense for standing still. When making quality adjustments to the CPI, this should be taken into account.
The authors wonder why I say they lack historical perspective. They were, after all, only assigned to draw conclusions about the current level of inflation. But if they applied the sort of analysis of quality the Boskin Commission undertook to past products, which they acknowledge often had a greater impact on our lives, I believe they would typically come up with even larger adjustments to inflation in earlier periods. As I noted in my review, and as Gordon discusses in his Brookings reply, these would begin to make no sense because they would imply that real economic growth was much faster than we have supposed, and that incomes in earlier eras were absurdly low. (Gordon says this may be explained by an overstatement of housing inflation, which I strongly doubt.)
Such considerations suggest that the size of the current quality adjustments is too large. My sense is that in general, the Boskin Commission methods have exaggerated the effects of new products on our lives simply because they are contemporary, especially when quality adjustments are based on so little hard evidence. These issues need further airing. There has been relatively little discussion or research among academic economists, or anyone else, concerning the more subtle issues relating to product quality and the standard of living over longer periods of time.
In my view, the Boskin Commission report has done some good by forcing economists and lawmakers to consider the issues it has raised more openly. It has called attention to the need for accurate statistics and to the budget problems at the BLS. It has made the BLS more alert, though I think in retrospect that the agency has performed unusually well, and often better than its critics have.
But the Commission has also politicized a statistics-gathering process that was once admirably free of any such influence. It has undermined without justification some of the credibility of the BLS. The Boskin Commission report should have been presented as no more than a program for more study, with arguments for refinement and reform of some BLS procedures and for more research. Yet the members of the Commission saw fit to urge Congress to reduce Social Security cost-of-living adjustments before the BLS had fully analyzed the issue. Such peremptory action was in no way warranted by the quality of the argument the Commission presented, or by the current state of research.
Although Congress has not accepted the Commission recommendations, I think that some of its unfortunate effects persist. Most important, the BLS has been encouraged to search for areas in which quality improvement may be understated, without any similar concern being expressed about how quality may have deteriorated. We must hope that academic economists will now give the issues surrounding the measurement of inflation more attention—and for the very reason the authors of the letter raise. These issues affect a wide range of economic data, including productivity, wages, and economic growth in general. The BLS, for its part, should be given the funds to do the job properly, free of political interference.
Finally, I think it will be clear to readers that I took nothing out of context when I quoted Griliches as saying the Commission’s data were “squishy.” I agree with him that indexing Social Security to wages is an idea worth considering more. But why do the authors criticize me for not discussing this allegedly “deeper” issue when I was writing not about Social Security but about the accuracy of the CPI—a subject that deserved more careful treatment than they gave it?
June 26, 1997