The Consumer Price Index (CPI) reported monthly by the Bureau of Labor Statistics (BLS) measures the average change in prices over time for a fixed basket of goods and services. The BLS calculates the CPI for two population groups: "All Urban" consumers, (CPI-U), and "Urban Wage Earners and Clerical Workers," (CPI-W). The latter is a subset of the former and represents 32 percent of the total U.S. population. The CPI-W is used primarily for calculating cost-of-living adjustments (COLA) for unionized workers and recipients of federal entitlements such as Social Security. Because the CPI-U is more comprehensive, it is used to adjust many entitlements and the tax code, besides being a measure of inflation.
In addition to these two CPIs, the 1987 amendments to the older Americans Act (1965) directed the BLS to develop an experimental index (CPI-E) for Americans 62 years of age and older. This index initially measured price changes during 1987 to 1993, and has been extended through 2000. Figure 1 shows the three index numbers since the inception of the CPI-E in 1982.
The rate of price increase in the CPI-E has always been greater than the other two index numbers. In April 2000, it was about 14.4 percentage points higher than the CPI-W (182.5 vs. 168.1). Over a five-year period from December 1995 to April 2000, the CPI-E has risen 19.9 percent as compared to 17.7 percent and 17.0 percent for the CPI-U and CPI-W, respectively. However, the indexes are not directly comparable because the CPI-E uses a market basket that may not reflect the actual purchases made by persons 62 and over. 1
For both the CPI-U and CPI-W, items in the basket are weighted according to their importance-known as expenditure weights- in the consumer spending for their specific populations. Whereas the CPI-U and CPI-W cover all age groups, the CPI-E refers to those urban consumer units in which (a) unattached individuals (not in the family) are at least 62 years of age; or (b) the reference person of the family or the spouse is at least 62 years of age; or (c) the reference person of the groups of unrelated individuals living together, who pooled their resources for living expenses, is at least 62 years of age.
In the 1984 Consumer Expenditure Survey, which is used in constructing CPIs, 3,135 (or 19 percent) of the total sample of 16,500 urban consumers satisfied the definition of the CPI-E population mentioned above. In 1995, the expenditure weights for the three CPIs varied as follows:
The expenditure weight of any item in the CPI is measured by the actual expenditure on that item in the base period. It represents the relative importance of that item in total expenditure. As commodity prices change from time to time, the relative importance is updated accordingly as percent change in expenditures. Since the sample of consumers aged 62 and older was much smaller than the total sample, the sampling error for the CPI-E, particularly in expenditure weights, is higher than for the other two index numbers.
Table below shows that the CPI-E rose 19.9 percent from 1995 to 2000, as compared to 17.7 percent for the CPI-U, and 17.0 percent for the CPI-W. Higher rate of increase in the CPI-E shows that consumers aged 62 and above allocate a larger portion of their total expenditure on those items that have grown more rapidly. For example, the elderly population needs to allot a larger proportion of their expenses for medical insurance (see expenditure weights) than the two population groups represented in the CPI-U and CPI-W, whose insurance is usually provided by employers. The price increase on medical services for elderly consumers was 37 percent as compared with 35 percent for the other two populations. Of all three CPIs, the CPI-E had the highest rate of price increase for all major categories except apparel and education. Medical care accounts for most of the difference between the CPI-E and other two index numbers.
The relative importance of items differed in the three index numbers, especially for medical care, shelter, and transportation. An important limitation of the CPI-E, however, is that prices of items within each goods and service category are based on the purchases of the entire CPI-U sample. For example, prices of medical services within the medical care category are selected from the purchases of the CPI-U population and may not be representative of specific services, such as nursing care, purchased by the CPI-E population.
Another limitation of using CPI-U prices is that they do not account for discount prices available to older Americans, such as senior-citizen discounts. Also, areas and outlets used in collecting prices are the same for all three CPIs, but these outlets may not necessarily represent places where older Americans buy their merchandise. This causes price-selection bias in the CPI-E which is already based on a much smaller sample. Because of these limitations, the CPI-E is classified as an experimental index, and any conclusions drawn from this index are only tentative in nature.
Besides the selection of items and price quotations, there are some other inconsistencies in using the CPI-E for indexing purposes. The Social Security inflation adjustments are currently based on the CPI-W averaged from the third quarter of one year to the third quarter of the next year and applied to benefits of the following year. If Social Security benefits were to be indexed by the CPI-E instead of the CPI-W, the COLA adjustments would be higher. But the CPI-E does not represent all Social Security recipients. Many Social Security recipients are younger than age 62--those who are surviving spouses and/or minor children, or disabled workers. Secondly, many workers do not start receiving Social Security benefits until they retire at age 65, while the CPI-E covers the entire population aged 62 and above. Using the CPI-E for Social Security adjustments would mean excluding some who are already receiving benefits, but including some (age 62 to 65) who are not into the program yet. These two population groups may not be sufficiently comparable in number to cancel out each other, nor can they be assumed to have identical spending habits.
Written by Satyendra Verma, Ph.D.
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Public Policy Institute, Public Affairs, AARP, 601 E Street, NW, Washington, DC 20049