Intermediate Run Recommendations

Recommendation vi.

The BLS should study the behavior of the individual components of the index to ascertain which components provide most information on the future longer-term movements in the index and which items have fluctuations which are largely unrelated to the total and emphasize the former in its data collection activities.

Elsewhere in their report, the commission emphasizes that the objective of the CPI should be to measure changes in the cost of living. That is, the CPI for 1998 should measure change in the cost of living during 1998. This recommendation, however, suggests that data collection activities should focus on a different objective, namely to provide information on the future longer-term movements of individual prices or the index as a whole. Forecasting inflation is a widespread and important use of the CPI, of course, but one that is conceptually distinct from the measurement of cost-of-living changes. If prediction of future inflation, or the measurement of "inflationary pressure," were the measurement objective of the CPI, this might imply different choices with respect to the formulas and weights used in construction of the index, as well as with respect to the allocation of the sample. The commission, however, emphasizes the use of the CPI as a measure of past and contemporaneous changes in the cost of living in choosing the index formulas and weights, on the one hand, while emphasizing the uses of the CPI in forecasting future price movements in determining the sample allocation, on the other. This appears to be an internally inconsistent strategy.

It is important to recognize that the BLS determines and allocates its data collection resources based on rigorous statistical considerations. Sample resources for the CPI are allocated between the two major price surveys, Commodities and Services (C&S) and Housing, according to the relative importance and variability of the survey estimators for each component, while taking into account the relative costs of each survey. The sample for the C&S component of the CPI is designed to allocate resources systematically among major item groups and sample cities, utilizing models to minimize the sampling variance of estimated price change over a six-month interval, as measured by the all items (less shelter) national CPI, subject to cost and sample coverage constraints. Solution allocations among items, outlets, and cities thus strike a balance with respect to the contributions of components of sampling variability by sample items, their relative importance with respect to the total consumer budget, and the relative cost of data collection and processing, while keeping within the cost and coverage constraints of the program.15

In its discussion of this recommendation, the commission suggests that resources devoted to the sample for bananas, a perishable fresh fruit whose price-change sampling variability has been estimated to be substantial, but whose price fluctuations are "not systematically related to the underlying trend movements of the CPI," would be better allocated to surgical treatments, consumer electronics, and communication services.16  The potential for saving resources by reducing collection of data for items like bananas is fairly limited because the marginal cost of collection and processing is quite small—the stores are already being visited to collect other grocery items and very little analysis is required after collection. Moreover, because the C&S sample has been allocated to minimize the variance of six-month price change, a reallocation of resources away from any item with a high sampling variance toward other items necessarily would diminish the reliability of short-term movements in the all items index.

In summary, the BLS believes that this proposed redirection of data collection efforts would be inconsistent with the primary objective of the CPI – to approximate changes in the cost of living. BLS thus does not plan to implement this recommendation.

Recommendation vii.

The BLS should change the CPI sampling procedures to de-emphasize geography, starting first with sampling the universe of commodities to be priced and then deciding, commodity by commodity, what is the most efficient way to collect a representative sample of prices from which outlets, and only later turn to geographically clustered samples for the economy of data collection.

Because geographical coverage impinges on many aspects of the CPI data collection and index estimation process, the practical meaning of this recommendation is somewhat unclear. As emphasized above, the allocation of the CPI sample has a rigorous statistical basis. By the same token, the importance of the geographic structure underlying the CPI makes it a continuing subject of BLS research, with the goal of improving the efficiency of CPI data collection activities and thereby the accuracy of the index.

Deciding, commodity by commodity, what is the most efficient way to collect a sample has been and will continue to be the standard BLS practice. In several cases, for example, postage and used cars, the BLS currently collects data on a national level. In most cases, however, it is not possible to select samples of specific items at the national level because of the lack of a national list (or frame) of items to sample, together with the sales volume information needed to determine the probabilities of selection. Moreover, if specific items were selected nationally, there would not usually be a feasible way to determine whether a selected item was, in fact, carried by any particular sample retail outlet. These considerations have led the Bureau to do sampling of items for pricing locally, by first selecting the urban area, then the outlet, and finally the specific item within the outlet. This method helps to ensure that the sample of items is timely and representative. The BLS is currently investigating potential uses of point-of-sale (scanner) data which are available from private vendors, and in the future it might be possible in some cases for the BLS to use such data to draw national samples of items.17

In summary, the BLS has no specific plans to implement changes to sampling procedures in connection with this recommendation. It is the current BLS practice to decide, commodity by commodity, what is the most efficient way to select samples. Samples are selected at the national level for some commodities, and BLS research will continue on the geographic structure underlying the CPI.

Recommendation viii.

The BLS should investigate the impact of classification, that is item group definition and structure, on the price indexes to improve the ability of the index to fully capture item substitution.

The BLS introduced a new item structure for the CPI with the release of data for January 1998.18 The ability of the index to capture consumer substitution was one of the prominent factors that was considered in developing the new item classification. In putting together the item classification, the BLS "also tried to see that [the strata] formed natural groups, as consumers would view them. For example, using the consumer view, items within the same stratum should have some affinity, such as substitutes (butter and margarine), or complements (washers and dryers)."19

The commission points to some examples of potential consumer substitutions which cross item boundaries, such as "on-line news services which compete with newspapers, automobile purchases with leases, and drugs with surgical procedures they replace," arguing that in these cases direct price comparisons are needed so that the full substitution effect can be measured.20  The BLS is sympathetic to the commission’s concern, and will continue to work to improve the CPI item structure.21  It seems to us, however, that no feasible item classification system would completely capture the current and possible future developments in consumer substitution behavior. Moreover, one must acknowledge that because any item classification structure relies on a combination of expert judgment and quantitative evidence, all such structures are by nature somewhat arbitrary and therefore arguable. Perhaps most important, it does not seem to us that the item classification system is necessarily the most significant impediment to measuring the effects of these substitutions. The more fundamental issue is the need to develop systematic methods for identifying the substitution and accounting for differences in quality between the substituted items.

In summary, the BLS instituted a new item structure for the CPI in January 1998 that was designed with an emphasis on its ability to capture consumer substitution. BLS will continue to work to improve the item structure within the normal framework of index revisions. Meanwhile, it will continue its research on substitution across item categories, focusing on the development of superlative measures of the cost of living.

Recommendation ix.

There are a number of additional conceptual issues that require attention. The price of durables, such as cars, should be converted to a price of annual services, along the same lines as the current treatment of the price of owner-occupied housing. Also, the treatment of "insurance" should move to an ex-ante consumer price measure rather than the currently used ex-post insurance profits based measure.

When the BLS adopted the rental equivalence approach to pricing housing services in 1983, BLS staff were aware that the same conceptual issues arise in the pricing of other consumer durables.22  In principle the CPI is intended to measure the cost of consuming goods and services, and durable goods provide a flow of services over time rather than immediate consumption. To implement a flow-of-services approach, however, requires information either on the costs that would be associated with renting the durable asset or the user cost associated with holding the durable asset. In the case of housing, the existence of rental markets makes it relatively easy to implement the former approach, commonly referred to as the rental equivalence approach, while the long life of housing assets and the likelihood of price appreciation made the standard asset price approach uniquely problematic. During the mid-1980s, BLS researchers investigated the potential use of automobile leasing data to price automotive services, but at that time concluded that the auto leasing markets were not sufficiently developed to support a leasing equivalence approach to index construction. Subsequently, automobile leasing has grown to the point that in 1998 an automobile leasing stratum was added to the CPI market basket. Currently BLS researchers are reexamining the flow-of-services approach for automobiles, possibly using a leasing equivalence methodology. For durables other than automobiles, the lack of widespread rental markets as well as the lack of data needed for direct estimation of user cost suggest that the flow of services approach may not be practicable.

The commission recommends that the BLS move the CPI for insurance to an "ex ante consumer price measure" from the currently used "ex post insurance profit based measure." The current CPI for health insurance does not directly price policies purchased by consumers.23  Instead, an indirect approach to measuring the price of a policy is used; the price is seen as deriving from the services provided by the insurer and the value of benefits paid to providers of health care. The BLS prices these two parts separately, obtaining from insurers information on retained earnings to measure changes in the value of the insurance service component, and using the price indexes in the CPI medical care component to measure changes in the cost of the health benefits paid to providers. It is possible that direct pricing of health insurance policies would have the virtue of automatically reflecting cost-reducing innovations in the treatment of medical problems (such as the substitution of less-costly outpatient procedures). The countervailing difficulty, however, is that health insurance policies can increase or decrease in price due to changes in coverage or in the characteristics of the covered populations, and these changes may be very difficult to observe or adjust for in the index.

The current CPI approach was adopted in 1964. Prior to that the CPI collected the price of the most widely-sold community-rated Blue Cross/Blue Shield policy. That approach was dropped, however, when it became evident that the quality of the policies was changing in ways for which it was difficult to adjust the policy price. In 1984-85 the Bureau experimented with the direct pricing of a sample of health insurance policies but the experiment was terminated because it again proved too difficult to maintain constant quality and coverage of risk over time. The BLS recognizes the importance of the health insurance price movements to consumers as well as to policy makers and will continue to search for ways to overcome the obstacles to accurate adjustment for changes in policy characteristics.24

In summary, the BLS is sympathetic to the general spirit of this recommendation and is investigating the flow-of-services approach for automobiles. The flow-of-services approach does not, however, appear to be practicable for most durables due to the lack of widespread rental markets and the lack of data that would be needed for direct estimation of user cost. Automobile and tenants insurance policies currently are priced directly in the CPI but health insurance is not, due to difficulties in maintaining constant quality and coverage of risk over time.

Recommendation x.

The BLS needs a permanent mechanism for bringing outside information, expertise, and research results to it. At the request of the BLS, this group should be organized by an independent public professional entity and would provide BLS an improved channel to access professional and business opinion on statistical, economic, and current market issues.

The BLS already has in place many mechanisms for bringing in outside information, expertise, and research results. Business and labor research advisory committees meet regularly with BLS staff and management and have long been a source of outside information and expertise. A price research division has been a part of the price index programs since 1965, and much of the discussion of CPI bias has been based upon the results of research conducted by BLS staff. BLS economists and statisticians routinely solicit opinions from outside researchers by presenting research papers at conferences and submitting them for publication at peer reviewed journals. Academic researchers are regularly invited to present their research findings to BLS staff in seminars. The Bureau’s American Statistical Association-National Science Foundation-BLS fellowship program brings in scholars for extended on-site research projects. The BLS has funded research by academic economists when research by experts was needed to solve difficult measurement problems.25

The BLS agrees that continued input from outside researchers is useful. For the past several years researchers at the National Bureau of Economic Research (NBER) Summer Institute have devoted specific sessions to index number issues and BLS staff have been regular participants. Earlier this year BLS asked several outside researchers to review the decision to adopt the geometric mean formula in the CPI. In addition, the BLS has participated with the Bureau of Economic Analysis (BEA) and the NBER in a project addressing the measurement of output and prices for medical care. Currently the BLS is pursuing a project with outside researchers regarding some of the conceptual issues underlying the construction of the CPI and its use for escalation.

In summary, the BLS has in place many mechanisms for bringing in outside information, expertise, and research results from business, labor, academic researchers, professional economic/statistics organizations, and other Federal statistical agencies. The BLS will continue to actively solicit such help.

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Last Modified Date: October 16, 2001