CPI or chained CPI what’s the difference?

the Consumer Price Index, CPIAUCSL, Chained Consumer Price Index, SUUR0000SA0, monthly, 2003 to 2013

Obama has proposed making fundamental changes to the way that various government benefits such as Social Security are adjusted for inflation. Specifically, its been proposed that the existing metric, the Consumer Price Index (CPI) be replaced with a different metric known as “Chained CPI”. What’s the difference?

The chart above shows two series: the Consumer Price Index (CPIAUCSL, black line) and Chained Consumer Price Index (aka, “chained CPI”, SUUR0000SA0, blue line), monthly for the period 2003 to 2013. To make the differences easier to understand I’ve based line each series at 100 in 2003. The vertical grey bar identifies the period of The Great Recession, which ended in June, 2009.

Some observations: across the period in question, CPI averaged about 1.32% higher than Chained CPI. The largest difference, 2.74%, was observed in December of 2012. Over the past year the difference between CPI and Chained CPI averaged 2.16%.

A visual inspection of the graph seems indicate the gap between CPI and Chained CPI is widening and this is supposed by looking at the numbers: before The Great Recession the difference between CPI and Chained CPI averaged 0.75%, while after The Great Recession the difference between the two series averaged 1.96%. Since July of 2012 the difference has been greater than 2%. Further,
in 57 of the 121 months during the period in question the difference was greater than 1%, and it exceeded 2% for 23 of the months.

Clearly by switching to Chained CPI the government will save money, both on a monthly basis but also in terms of the compounding effects of the reduced payments over time. I’m not totally sure why the difference between the two series is widening so I’ll dig deep into this as time permits.

Switching to Chained CPI isn’t a new idea; the switchover was first identified in 1996 by The Boskin Commission. The fundamental idea underlying Chained CPI is that as prices change people switch the goods they acquire, but these qualitative substitutions aren’t properly modeled.

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