Question

In the 1990s politicians in Washington D.C. were looking for ways to balance the budget. Former Federal Reserve Chairman Alan Greenspan brought attention to the importance of the Consumer Price Index (CPI) and its link to cost-of-living adjustments (COLAs) in several areas of the federal budget--most notably Social Security. Alan Greenspan argued that the CPI overstated inflation and thus led to unjustified COLAs. According to Alan Greenspan, these unjustified COLAs therefore increased the deficit, and if the overstatements in the CPI were corrected this would contribute to balancing the budget.

The Senate Finance Committee created the Boskin Commission in the 1990s to examine possible overstatements of the CPI. The commission came out with its estimate that the CPI overstated inflation by 1.1%.

Answer the following questions:

1. If the Boskin Commission's estimate was right and the CPI overstates inflation by 1.1 % every year--what does that say about real GDP per capita and living standards in general in the United States, which are affected by the CPI ?

2. What are some of the sources of this possible overstatement of the CPI, which is calculated by the Bureau of Labor Statistics?

Answer 1

1. Inflation is persistent increase in general price level of goods and services in the economy. We differentiate between real GDP growth and nominal GDP by accounting for inflation rate.

Now, if If the Boskin Commission's estimate was right and the CPI overstates inflation by 1.1 % every year - it means although real GDP per capita increases every year by 1.1% more than the calculated increase at overstated inflation rate or in other words real wages, output and income level have in fact increased more than the calculated estimate by the government. Therefore, real GDP per capita and living standards in general life is higher than what government estimates at overstated inflation rate.

2. Some of the sources of the possible overstatement of the CPI are non-accountability of prevalence of discount stores such as Walmart, Amazon. Other sources may include quality-bias of high technology products and services such as computers which have become much more efficient and can be purchased at the same price or below its price 10 years before, however its productivity may have increased drastically.