Magazine article Management Review

Consumer Price, Consumer Hype

Magazine article Management Review

Consumer Price, Consumer Hype

Article excerpt

The U.S. Consumer Price Index wasn't designed to be a cost-of-living index - but it's the best indicator we've got. Or is it?

Six years ago, Bill Lewis, director of Washington-based McKinsey Global Institute, the high-powered corporate think tank of McKinsey & Co., realized he had a problem. The numbers he and his fellow consultants and economists were using to forecast economic growth, especially the core U.S. Consumer Price Index, were off. Plainly and simply, they weren't measuring with any precision how much America's cost of living was growing.

"Over one year, it's not a big difference," Lewis says. "But compound that for 10 years, [and] suddenly you're planning under uncertainty."

It has taken six years, a top-level commission chaired by Stanford University economist Michael Boskin, and bipartisan pressure from Congress and the White House, for that realization to dawn on Washington's policymakers. But the problem remains: What to do now?

The crown jewels of the Consumer Price Index are kept by a group of what Everett Ehrlich, under-secretary of commerce for economic affairs, the department's chief economist, describes as "monks [who] show intense devotion to their task" and who labor in the "monastery" of the Bureau of Labor Statistics.

The central characteristic of monasteries and their monks, however, is their detachment from the world beyond their walls. This may, it turns out, be the root of the problems of the index and, by extension, all global industry that must plan and forecast around these numbers.

The Prognostics

The Consumer Price Index, by definition, is a measurement of the change in prices of a "market basket" of products and services across the United States. Established once each decade, this market basket currently consists of 207 different products comprising at least 90,000 models and styles. New cars, for instance, might be one product, but there are 135 different models priced in 85 different metropolitan areas, according to Patrick Jackman.

Jackman is, for all practical purposes, the senior monk - an economist in the Office of Prices of the Bureau of Labor Statistics (BLS), a unit of the U.S. Department of Labor. The two departments of Labor and Commerce divide the task of keeping the nation's economic statistics. And there are many such indicators - the gross domestic product (GDP) compiled by the Commerce Department's Bureau of Economic Analysis (BEA); the Consumer Price Index calculated by the Labor Department's BLS; the employment and wage reports; the Producer Price Index, which defines wholesale prices, even such arcane indices as the Voluntary Quit Rate and freight car loadings.

Francis Mer, chairman of the French steel company Usinor, has said that the economic data gathered by the U.S. government and provided to U.S. companies is of better quality and greater timeliness than anywhere else in the world. And, he says, this is "one of the reasons why U.S. companies are better-managed than their European counterparts."

Commerce's Ehrlich goes even further: "The CPI is of broad importance throughout the economy, telling savers and investors how much of their returns are genuine and how much illusory, telling workers how much of their reward is genuine and how much illusory, telling business planners the most important components of their competitive environment - the structure of costs."

But Jackman of the BLS is more modest. "People are asking the CPI to do things that it was not designed to do," he says. "We never said it was a cost-of-living index. It is not designed to show how people change their spending patterns. We take a market basket of goods and services and reprice these items month after month until the next major revision. We are moving toward a cost-of-living index, but we are not there yet."

Which brings us precisely to the core of this debate. Last year, the Boskin Commission released a detailed report saying that the index overstated inflation by an average of 1. …

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