Inflation and the Cost of Living

The news media has been reporting some of the discussions between the two major political parties in the “reduce spending/raise taxes” debates –especially as they relate to “entitlement” reforms such as Social Security. One of the items being mentioned by the presidential administration is a change in the method of calculating cost of living adjustment (COLA) for Social Security benefits. The change basically involves changing how the Consumer Price Index (CPI) that drives the benefit increase is calculated.

Calculation of the CPI is complex and different people will be affected by it differently depending on the actual “basket of goods” they purchase. We are not going to have an in-depth discussion on the actual calculations and associated nuances here. If your actual purchases are food, energy, healthcare, and education related, your cost of living is greater than the approximately 2% the government is calculating now. The new idea is to use a “chained” CPI for calculating benefit increases. Chained CPI basically assumes that consumers will actually change their buying habits rather than just seeking cheaper brands. For example, if the price of beef goes up, consumers will start buying more chicken and not just substituting hamburger for steak. Hence the actual cost of living for the consumer should be based on the increase in chicken prices instead of beef.