Consumer Price Index

One of the most important economic indexes produced by the federal government is the consumer price index (CPI). Last year, nearly $500 billion in federal spending, such as checks to Social Security recipients, was tied to price changes measured by the CPI. The CPI is also used each year to adjust for inflation various aspects of the federal income tax, from tax brackets to personal exemptions. As a result, nearly every American is affected by changes in the CPI. The CPI tracks the prices of a fixed market basket of goods and services that consumers buy. The market basket contains thousands of different products and services, and the Bureau of Labor Statistics (BLS)--which publishes the index--tries to obtain prices on the exact same items each month. Sometimes, however, BLS cannot find the exact same items. When this happens, BLS price takers in the field "substitute" a new version of the product for the old one. If BLS' commodity analysts later decide that there are significant differences between the items and their substitutes, they make what BLS calls "quality adjustments" to separate pure price changes from price changes that are due to other factors, such as differences in quality, size, or quantity. Evidence exists that substitutions have a significant impact on the CPI. This report describes (1) how commodity analysts decide whether to make adjustments, (2) the adjustment methods they use, and (3) how supervisors of commodity analysts review the analysts' decisions.

GAO noted that: (1) commodity analysts use a combination of professional judgment, general procedures, specific methods, and limited written guidance in deciding whether and how to make adjustments for substitutions; (2) in making adjustments, BLS' objective is to include only pure price change in the calculation of the CPI and eliminate price change that is the result of other factors; (3) commodity analysts receive and review information about the old and new versions of the commodity from which they make a series of determinations that revolve around whether the two versions are similar and, if not, which adjustment method to apply; (4) for items that are judged to be comparable, no adjustment is made; (5) when a substitution is not comparable with the item it replaces, commodity analysts either use a direct adjustment method to make an adjustment themselves or assign one of two indirect methods, in which case the BLS computer programs make the adjustments; (6) direct adjustments are made when the specific cost of a quality change can be estimated either by the manufacturer of the items or by using BLS' statistical models that incorporate price data; (7) when a direct adjustment is warranted but cannot be made, commodity analysts apply one of two indirect adjustment methods that impute a rate of price change; (8) both methods impute the pure price change by averaging the rates of price changes experienced by the same type of items in the CPI; (9) the class-mean method is generally used for products where new models or product lines are introduced fairly regularly; (10) it is based on the rate of price changes experienced by other substitutions in the particular geographic area; (11) the linking method includes all items of the same type and in the same location as the item in question, and it is most heavily influenced by items that had not changed; (12) according to BLS, there are no guidelines or policies in writing for supervisors to follow in selecting and reviewing the substitution decisions of the commodity analysts; (13) there is an unwritten policy that supervisors are to review substitution decisions when they consider the price increase or decrease to be too large; (14) BLS has no policy to randomly or otherwise select and review substitution decisions; and (15) GAO found no evidence to indicate whether errors or inconsistencies in commodity analysts' decisions or lack of comprehensive reviews has had a material effect on the calculation of the CPI.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

Director: Team: Phone: