Measuring Inflation in a High-Tech Age

November/December 1995

Business Review — When Americans ask themselves former New York Mayor Ed Koch's favorite question "How'm I doing?" many of them may answer, "Not so hot." For when they look at their "real wages" corrected for inflation using the Consumer Price Index (CPI), it appears that many Americans are earning less than they were two decades ago.

Is this really the case? Or is the CPI misleading as a standard for purchasing power?

I will argue that the answer to the second question is yes, which is disturbing for several reasons. What we normally mean by inflation is the loss of purchasing power of dollars. If the CPI is giving an upwardly biased view of inflation, then our inflation-adjusted measures of consumers' purchasing power and well-being will be too low. As we shall see, there is some evidence that the CPI has been upwardly biased more than 1 percent annually over the past 20 years. If the CPI is revised down 1 percent annually, the post-1975 decline in real wages disappears. Second, many economic payments — including major ones such as Social Security benefits and federal income taxes — are tied to CPI to insulate them from inflation, but the CPI may be systematically distorting them.

This article appeared in the November/December 1995 edition of Business Review.

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