What you need to know about chained CPI — a (relatively) simple story

I admit it — when I read that the latest fiscal cliff debate was over chained versus unchained CPI, my first reaction was to hide my head under a pillow until it all goes away. I’m a policy wonk, but I don’t like economic esoterica, and I did not want to have to learn about a whole new concept in order to follow the budget debate.

Let’s face it: I would probably be perfectly safe with the general assumption that anything the Republicans propose will take money from the middle class and the poor, so I’m agin it.

On the other hand, that’s precisely the kind of simplistic, knee-jerk reaction that I fight against all the time in all kinds of arenas. So I sighed and set about unraveling the mysteries of chained CPI. Luckily for me — and for you — it’s not nearly as complicated as it sounds.

First, there’s CPI — the Consumer Price Index, which measures the cost of living based on the price of a fixed basket of goods. (Think groceries, but also the cost of housing, health care, transportation, etc.) The CPI is used to determine the amount of cost-of-living increases for many things, including social security payments. If Grandma gets $1000 a month in Social Security payments, and the CPI increases by three percent, her check will go up to $1030. Simple, right?

Then the economists and politicians start complicating things.

Writing in The Atlantic, Zachary Karabell explains:

The primary measure of inflation, the Consumer Price Index (CPI) uses a fixed basket of goods that resets periodically. Chained CPI uses a basket of goods that adjust more fluidly to account for what statisticians and economists call “the substitution effect.” A fixed basket of goods is easier to calculate: just define the basket and then measure the price changes. But in the real world, people don’t passively accept changing prices. They change their behavior. The price of gas goes up? People drive less; they carpool more; they buy more fuel-efficient cars and consume less gas. The price of a domestic flat screen television goes up? They buy a less expensive import. In short, people don’t necessarily bear rising costs passively; they react and shift to maintain their standard of living. The traditional CPI index doesn’t capture that.

Chained CPI means a recalculation that takes into account the changes in people’s buying behavior due to price increases. In theory, chained CPI means that the price of the basket of goods changes upward because of inflation, but downward because then people will just buy cheaper stuff.

Is that a rational adjustment? Should we peg policy — and specifically, adjustments in social security payments — to chained CPI rather than simple CPI?

On the surface, that sounds semi-reasonable, but dig deeper and there’s a real problem. It’s the same kind of problem that I find in all those “cut calories in three simple steps” articles in the women’s magazines. A typical “simple step” is something like switching from regular soft drinks to no-cal diet drinks, thereby cutting 200 calories a day. That doesn’t work for me — I already don’t drink sugared drinks.

Similarly, “chained CPI” doesn’t do anything for the senior citizens who have already cut expenses to the bone. Switching from more-expensive oranges to less-expensive apples works if you have been buying oranges. It doesn’t save money if you have already had to cut fresh fruit from your diet in favor of cheaper canned stuff. So basing cost-of-living increases on the lower “chained CPI” will mean hardship for the poorer seniors who need social security the most.

So there it is — chained CPI is a useful economic idea, but basing social security increases on it is bad social policy.

If you want more on the argument, here are some good places to start:

Who’s Afraid of Chained CPI? The Atlantic

What is Chained CPI? Politico

The “Chained CPI” Cut: If you can’t dazzle them with brilliance … HuffPost

The Deal Dilemma Paul Krugman

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