OK

There have been many diaries and comments attacking the chain-weighted CPI, but one argument occurred to me that I have not seen elsewhere.  In the example below, I have made some simplifying assumptions that are in one sense unrealistic (such as a \$24 Social Security check), but I believe that such simplifications do not affect the essence of the situation, while allowing us to examine the matter more clearly.

Imagine a simple basket of goods, one with only two items in it, beef and chicken.  At the beginning of a ten-year period, the beef costs \$4 per pound, and the chicken costs \$2 per pound. Let us further assume that at these prices the average person consumes 4 pounds of beef and 4 pounds of chicken each month, costing him \$24.  Finally, let us assume that his Social Security check is also \$24 per month.  Therefore, his entire check will exactly pay for his consumption of these two items, at the beginning of the decade.

If the price of beef goes up relative to the price of chicken, he eats more chicken; if the price of chicken goes up relative to the price of beef, he eats more beef.  The chain-weighted CPI is supposed to reflect the substitutions he makes, whereas the ordinary CPI ignores the substitution effect, and merely calculates the increased cost of that original basket, with the 4 pounds each of beef and chicken in it.

Now let us assume that at the end of the decade, by a remarkable coincidence, beef costs twice as much as chicken per pound, just as it did at the beginning.  If he has received a cost of living adjustment according to the traditional CPI, then once again his entire check will still pay for the 4 pounds of beef and the 4 pounds of chicken.  But, if he has received cost of living adjustments according to the chain-weighted CPI, his check will have lagged behind the traditional CPI adjustment by 0.3% per year, amounting to about a 3% difference over the decade.

The argument for the chain-weighted CPI fudges the distinction between a temporary substitution and a permanent one.  It would not be so bad if he ate a little more chicken than beef when the cost of beef went up relative to the cost of chicken, so long as he could return to the same ratio of beef to chicken consumed (in this example, 1:1) when the ratio of the cost of beef to chicken returned to what it had been earlier (in this example, 2:1).  That would be a temporary substitution.

But he cannot.  At the end of the decade, when the relative costs are the same as at the beginning, the person in our example is forced to make a permanent substitution of more chicken instead of beef.  My use of the word “permanent,” of course, is relative.  As the process continues, every time the cost ratio of beef to chicken returns to that of 2:1, we will observe another permanent shift toward less beef and more chicken.

According to my calculations, in just over 100 years, the original \$24 adjusted for inflation by the chain-weighted CPI would force beef right out of the basket.  The hypothetical person would have to eat nothing but chicken.  It won’t be the same person, of course, but rather this situation would apply to some future generation.

This example, which illustrates the difference between temporary and permanent substitutions, is merely theoretical, and is advanced only for the sake of contemplation.  It has no practical consequences whatsoever, for even if brought to the attention of president Obama and the representatives and senators who are eager to use the chain-weighted CPI, they would be unmoved.  They want to cut Social Security, and they have finally found just the right obfuscation to pull it off.

In such discussions, we must distinguish between the propositions that are true, the actions that would be right, and the people with the power to ignore them.  My argument is just one more argument leading to the true conclusion that using the chain-weighted CPI would be a cut to Social Security.  I further assert, without argument, that doing so would not be right.  Well, two out of three ain’t bad, but it won’t be enough.  Those with power will brush aside what is true and what is right as if they were just a couple of crumbs on the table.

I hope everybody likes chicken.