The government knows how much it costs.

What You Think About Inflation Is Wrong

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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I got a lot of responses to yesterday's post on the varied uses of inflation statistics, but one popped up over and over: "OK, I can see why the Fed would pay less attention to food and energy than to the broader price index, but the government still shouldn't use core inflation (excluding food and energy) to calculate cost-of-living adjustments."

This seems worth a quick note, because the government doesn't use core inflation to calculate cost-of-living adjustments. The federal government uses the CPI-W, a consumer price index of inflation for urban wage earners and clerical workers. State governments can set their own, but I'm aware of none that are indexed to core inflation rather than a broader index. Federal workers have their raises approved by Congress, which may reference any index it pleases but probably doesn't look at core inflation, either. As for the private sector, the last available research I could find on cost-of-living adjustment indexes in union contracts dates to the mid-1980s, so I suspect that this isn't a big issue for union workers, either.

Nonetheless, this belief seems to be incredibly widespread. I'm not sure why, though I can guess at two reasons from the e-mails I've gotten.

One is the mistaken belief that there is an "official inflation rate" used by all agencies for all purposes. This is incorrect. All the inflation rates we have are "official rates"; there's not one that's more official than the other.

The other is that food and energy loom disproportionately large in the budgets of retirees. They've already acquired a lot of stuff, so they're less apt to get excited about fantastic deals on television sets and furniture manufactured in China. On the other hand, they buy food and gas and medicine every month. When they see how much those expenses carve out of their income, they think "My income is not keeping up," and the idea that the government is using the wrong inflation index seems like a reasonable explanation for why it's so hard to make their money stretch.

But however compelling this explanation may seem, it's wrong. The government knows about food and oil prices. And it's taking them into account when it calculates your Social Security check.

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