Medical Costs Are In Orbit, Right? Well, Maybe

If inflation is losing steam, it's not yet apparent in the cost of health care services. In the 12 months ending in February, the cost of medical care services, as reflected in the consumer price index, was up a hefty 9.9%. At last count, however, another yardstick of health care inflation--the personal-consumption-expenditures (PCE) deflator for medical services--was up only 5.9% over its year-earlier level.

That sharp divergence has led economist Edward E. Yardeni of Prudential Securities Inc. to speculate that the CPI is overstating the problem. But others respond that while the PCE deflator may be a more accurate measure of economywide medical inflation, the CPI may be telling a truer story about the health costs experienced directly by consumers and employers who rely on their own resources to pay medical bills.

Yardeni points out that the CPI's health care component is based on a fixed basket of medical goods and services. The deflator, on the other hand, measures the prices of such goods and services that are actually consumed--meaning that its weights change as consumption patterns change. If rising hospital costs induce patients to opt for less-expensive ambulatory care, for example, that shift will be reflected in the deflator. "Because the CPI doesn't reflect the steps people take to avoid rising medical costs," says Yardeni, "it tends to paint too dark a picture."

Another difference is that the CPI's price index for hospital costs is based on a survey of the prices posted by hospitals, while the PCE deflator for hospital services is mainly derived by measuring rises in input prices, such as wage costs. Both approaches have problems: The CPI is likely to miss quality changes in hospital services, and the deflator neglects gains in labor productivity.

The most significant difference, however, may be that personal-consumption expenditures include government spending for health care under such programs as medicare and medicaid, as well as private spending. Thus, the PCE deflator for medical services will tend to be held down by the stringent medical cost-limiting measures adopted by federal and state governments in recent years.

The CPI for medical services, however, mainly reflects prices paid by the private sector--by consumers and employers. And many observers believe that government limits on medical outlays have inspired considerable cost-shifting to the private sector, causing prices there to rise even faster. If that's the case, says a Commerce Dept. official, "it's not surprising that the CPI's picture of medical care inflation is more alarming."

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