The Consumer Price Index As a Measure of Inflation

A consensus is emerging among economists and policymakers that the consumer price index
(CPI) as a measure of cost of living has an upward bias. As a result, downward revisions of cost-of-
living adjustments are frequently recommended, especially in discussions about deficit
reduction. Such revisions would lower the rate of increase of some entitlements and raise the rate
of increase of federal government revenue by reducing future adjustments to tax brackets. In this new working paper, Dimitri B. Papadimitriou, executive director of the Levy Institute,
and L. Randall Wray, research associate of the Levy Institute and associate professor of
economics at the University of Denver, express their surprise that this discussion has not been
broadened to include the use of the CPI as a measure of inflation and a target of monetary policy.
The Federal Reserve has increasingly pursued the single goal of price stability, or zero inflation,
although according to Papadimitriou and Wray, it has been unable to find a target that it can hit
and to demonstrate a consistent link between any of its targets and inflation. The authors argue
that if the CPI overstates inflation and the Federal Reserve uses it as a target, the Fed is basing
its policy on a measurement error. Given recent findings of measurement bias in the CPI, they
contend that it is inappropriate at this time to identify zero inflation with a constant CPI. In a
detailed analysis of the components of the CPI they conclude that the CPI is not a reliable guide
for policy purposes. They question whether tight money can reduce inflation as measured by the
CPI, and they note that the impact of such a policy could be perverse.