MUNCIE, IN – One of the primary goals of the Federal Open Market Committee (FOMC) is to keep the U.S. inflation rate at two percent. This magic number, if met over a given period, allows the Fed to satisfy its mandates of maximum employment and price stability. Despite the Fed insisting it uses “various indexes” to determine inflation, the consumer price index (CPI) remains the most important measure for average Americans.
The CPI determines several very important aspects of people’s lives, including the Social Security benefits they receive and if they get a raise at work. The index is also a hot-button issue for politicians and bank policymakers who are either trying to get re-elected or lionized, respectively.
A 2011 study published in the journal Psychology Science found that academics have enough flexibility with numbers to prove almost any hypothesis with manipulated stats. The way CPI is calculated has changed several times since the early 1980s. The following is a quick overview of those changes:
When President Ronald Reagan took office in January of 1981, the CPI was 11.8 percent, reports USinflationcalculator.com. Granted this was much better than the 14.8 percent just 10 months prior. But the country was in the midst of recession due to high inflation and high interest rates set by the Federal Reserve. Reagan recognized that interest rates and inflation were positively correlated thus, if one dropped, the other would too.
The Fed controls interest rates, but the federal government can control inflation via the Bureau of Labor Statistics (BLS). Several tweaks were made to the equation that determines CPI, most notably the cost of renting a home replaced the cost of buying one. Some economists and bloggers called this “cooking the books.” Regardless, CPI dropped to 2.5 percent by the middle of Reagan’s second year.
Great Gingrich/Clinton Compromise
Democratic President Bill Clinton and Republic House Majority Leader Newt Gingrich were not (and today are not) friends. But mutual business acquaintances and interest in political gain brought them together enough to leave the U.S. Treasury with a budget surplus in the 1990s.
Ironically President Clinton selected soon-to-be Fed Chair Janet Yellen as Chair of the White House’s Council of Economic Affairs in 1997. One of Yellen’s first acts was creating what is known as chained CPI, a new calculation that would virtually eliminate cost-of-living increases for Social Security recipients. The BLS, with a little coaxing from Fed Chairman Alan Greenspan, ultimately adopted the equation, but did not apply it to Social Security.
Chained CPI Under Obama
The idea of cost-of-living adjustments for Social Security recipients based on chained CPI was also being considered by the Obama Administration. Some of his Democratic colleagues rejected the proposal due to the negative effects it would have on seniors. Social Security benefits would increase slower, while tax revenue rose quickly, according Mark Zandi, Chief Economist at Moody’s Analytics, an economic forecasting and bank stress testing firm. The president has since backed off the idea, but Republicans have tried to revive the discussions recently.