How Does the New Lower Inflation CPI Rule Under the Republican Tax Bill Work?
Inflation is a fact of life. Nearly every year, prices and costs of living increase. The Bureau of Labor Statistics (BLS) keeps track of various inflation rates. One is the Consumer Price Index or CPI.
The CPI adds together a large "basket of goods" roughly equivalent to what a typical family buys, adds it all together, they compares prices every month to determine the inflation rate.
Under the current tax bill, government would no longer use the CPI but rather this strange thing called the "Chain CPI."
The Chain CPI lowers inflation by assuming that consumers will substitute one good for another when the price of one increases faster than another. By plugging in products that have seen lower inflation to replace those that have seen higher inflation, the overall index winds up lower.
SUBSTITUTING ITEMS TO MINIMIZE INFLATION
If the price of beef goes up 5 percent and the price of chicken goes up 2 percent, the basket of goods would be changed to include less beef and more chicken, thereby providing a lower official inflation rate under the Chain CPI than under the old CPI standard.
Over time, one substitution could lead to another. Next month, chicken could go up more than Spam, so spam is substituted in. Then, spam could go up faster than dog food, so dog food is substituted in. Eventually, the basket of goods has been so downgraded as to not reflect anyone's reality.
SWAPPING ITEMS TO MINIMIZE INFLATION
While substituting one item for another reduces the official inflation rate, swapping one item for another would make inflation magically disappear.
Let's say in the first month, beef prices increase by 5 percent, while chicken prices increase 2 percent.
The Chain CPI assumes people switch from beef to chicken. To make this example simple, let's say that the Chain CPI throws out all of the beef and substitutes in all the chicken, and let's assume this is the only item in the basket.
The official inflation rate becomes 2 percent the first month.
In the second month, beef prices increase by 2 percent while chicken prices increase 5 percent.
This time, the Chain CPI assumes people switch from chicken to beef.
The official inflation rate becomes 2 percent the second month.
See what happened there?
The cost increase of beef was hidden by substituting chicken in the first month, then the cost increase of chicken was hidden in beef the second month. Pretty clever.
So in the two months when there is an official total inflation rate of 4 percent, the actual inflation rate for people is closer to 7 percent [(2 + 5)/2 + (5 + 2)/2)].
REAL WORLD EFFECT OF LOWER OFFICIAL INFLATION
The CPI is used to calculate benefit and wage increases. If the Chain CPI replaces the regular CPI, then over time, we may all be eating dog food -- or at least those of us who depend upon the CPI for benefit and wage increases.
However, we are assuming only consumers would make changes to their consumption. How do you think this would affect producers? Do you think they would invest in technology to try to lower marginal cost and remain competitive?
Great questions and welcome to Steemit!
Proponents of the Chain CPI are "assuming" that consumers will change their behavior in predictable ways, by preemptively adjusting the basket of goods. The better practice would be to make such adjustments after the basket of goods has in fact changed, as is currently done.
Producers who tie wage increases to the CPI would benefit insofar as they could cut those increases, taking that difference in ever-increasing profits.
Producers will invest in technology every time it may significantly lower costs, regardless. For those who tie wage increases to the CPI, it is possible that there may be a tiny number who delay using new technology. However, I would not expect many for the simple reason that the difference between the higher CPI and the lower Chain CPI will take time to grow, whereas technological costs are dropping fast.
My submission is written to help people understand the concept and the general direction -- namely, that consumers will be harmed by this change.
That makes a lot of sense, thank you
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