Testimony of Katharine G. Abraham Commissioner of Labor Statistics Before the Subcommittee on Human Resources House Committee on Government Reform and Oversight April 29, 1998

I very much appreciate the opportunity to appear once again before the Subcommittee to discuss the Consumer Price Index (CPI). As I indicated in my testimony a year ago, the Bureau of Labor Statistics (BLS) has a long tradition of being in the forefront of price measurement research and operational innovation. In that testimony, I chronicled a lengthy list of CPI improvements introduced by the BLS over the years, emphasizing especially important improvements introduced in 1995, 1996 and the first part of 1997. My understanding is that the Subcommittee wishes to review both the further changes we have made since last year and our plans for future improvements. I am proud of the progress we have made, and welcome this opportunity to review our accomplishments and discuss our future plans.

As the Subcommittee’s invitation of April 17 notes, the BLS introduced a number of very important changes in the CPI effective with the data for January 1998, released two months ago on February 24. To be more precise, the CPI now is based on consumer spending patterns for the 1993 through 1995 time period, a new sample of geographic areas that better represents the current distribution of the U.S. population, and a new classification structure that better reflects the categories of goods and services consumers buy. These important changes represent the attainment of some of the more critical objectives of the large-scale effort to revise the CPI for which funds were first received in Fiscal Year 1995. Although major components of the CPI Revision project continue through Fiscal Year 2000, the changes introduced in February complete the expenditure weight and geographic area sample updating that also have been core components of every prior CPI Revision.

Although the updated market basket introduced in January is considerably more current than that it replaces, it still was 3 years old as of its introduction date. Our proposed CPI improvement initiative, which I will discuss in a few moments, will allow us to introduce future expenditure weight updates in a more timely fashion. Further, it has become apparent that shortening the roughly 10-year interval between comprehensive updates to the CPI would be desirable, and we have work underway to determine a more appropriate time schedule for such updates. I should note, however, that the availability of new Census of Population information likely always will necessitate some form of periodic CPI updating to account for shifts in the distribution of the population. Thus, I suspect that updating of the CPI geographic sample may well, of necessity, remain a decennial statistical activity.

Finally, both for the sake of completeness and because it is important in its own right, I should call the Subcommittee’s attention to an improvement in the treatment of quality changes in personal computers also introduced with data for January 1998. The revised item classification structure for the CPI that I already have mentioned includes a new stratum called Personal Computers and Peripheral Equipment. Analysts in the BLS Producer Price Index (PPI) program earlier developed and implemented a regression procedure, called a hedonic model, that attaches an implicit price to each important feature and component of the computer. Starting with the CPI for January 1998, when a personal computer or selected item of peripheral equipment, such as a modem, in the CPI sample improves in some way, a regression-based quality adjustment to its price will be made. The value of the improvement, as derived from the regression estimates, will be deducted from the observed price for the product. Conversely, if a model deteriorates, the value of the difference will be added to the price. Application of this method will improve our measurement of price change for personal computers and peripheral equipment.

Up to this point, I have focused principally on the changes to the CPI introduced with the data for this past January. Now, as your invitation to testify requests, I would like to turn to the announcement we made earlier this month concerning the use of the geometric mean formula in the monthly CPI. We expect to incorporate this change into the CPI for the month of January 1999, to be published next February.

When I testified before the Subcommittee last year, I spent a considerable amount of time discussing the issue of substitution bias. At that time, I noted that BLS had begun publication of an experimental index utilizing a formula which allowed for some degree of consumer reaction to change in the relative prices of the goods and services being purchased. Prior to my arrival at the BLS in 1993, CPI staff had raised the possibility of adopting a geometric mean formula in some or all index components, possibly in conjunction with the CPI Revision then being launched. By 1996, the issue had become a key element of the report of the Senate Finance Committee’s Advisory Commission to Study the CPI. In April of last year, we reported that we would conclude our review of the issue and announce our decisions by the end of 1997, and that we would incorporate whatever changes we believed prudent in the CPI to be published for the month of January 1999.

As I indicated in my March 31 letter to you, and as we also indicated in making our announcement the week before last, we found the evidence relevant to assessing the use of the geometric mean to be much sparser than we had expected. Taken in its entirety, however, the evidence unambiguously supports the proposition that consumers can, and do, alter their purchasing behavior in response to changes in the array of prices that they confront in the market place. Because the geometric mean estimator can better reflect the effects of such changes in consumer spending than can the current CPI formula, we have decided to implement the geometric mean estimator in most CPI basic indexes. The changes we will be making were announced on April 16, and, as originally planned, will become effective with data for January 1999.

The geometric mean estimator will be used in index categories that comprise approximately 61 percent of total consumer spending represented by the CPI-U and 64 percent of that represented by the CPI-W. The remaining index categories, which are shown on the attached table, will continue to be calculated as they are currently. Based upon BLS research, it is expected that adoption of the new formula will reduce the annual rate of increase in the CPI by approximately 0.2 percentage point per year.

Finally, Mr. Chairman, I would like to turn to the last question posed in your letter, which I believe was aimed principally at ascertaining our future plans and the resources required to implement those plans. In this regard, I would like to call your attention to the BLS Congressional Budget request for Fiscal Year 1999, in which we are seeking to build upon an initiative, started in 1998, to lay the groundwork for future improvements in the timeliness and accuracy of the CPI. For Fiscal Year 1999, our request seeks a total of $11.2 million and 47 FTE for the second phase of a three-year buildup to put this improvement program in place. The proposal has four major pieces.

First, in order to improve the timeliness of future CPI Revisions, we are proposing an expansion of approximately 50 percent in the size of the sample of households that supports the Consumer Expenditure Survey. About four-fifths of the proposed cost of the CPI Improvement proposal would be devoted to this project. At the present time, three years of expenditure data are required to construct a CPI market basket with an acceptable degree of accuracy. The proposed expansion will reduce the number of years of expenditure data required to two. Combined with a separate project to modernize the CPI market basket update system, this expansion will allow the BLS to reduce substantially the lag between collection of expenditure information and the introduction of future updated CPI market baskets. If funded, this proposed change will greatly enhance the Bureau’s ability to adopt a policy of more frequent weight updates.

In addition to supporting more timely updates of CPI expenditure weights, the expanded sample for the Consumer Expenditure Survey also will support the publication of production-quality superlative indexes which, as I mentioned in last year’s testimony, will account for substitution across CPI item categories in response to relative price changes. At present, these measures are produced on an experimental basis, and the CPI improvement proposal will provide us with the additional resources needed to produce them on a regular schedule, to a higher standard of precision and reliability.

Finally, we are requesting funds to support expanded pricing of goods and services together with the collection of richer information on those items’ characteristics, to support additional regression-based quality adjustment applications. While it is not possible to predict the outcome of this work in advance, we do know that application of these methods has proven to be of value in improving adjustments for changes in product characteristics. In addition, for particular item groups that are greatly affected by the introduction of new goods, BLS will be able to replace or augment existing samples of priced items, the objective being to bring new goods and services into the index on a more timely basis.

In summary, Mr. Chairman, with the support of Congress and the Administration, the BLS has been able to make substantial progress in improving the accuracy and relevance of the Consumer Price Index. Certainly, more can and will be accomplished. But, just as certainly, further progress depends critically on the continued support of those making decisions about the Federal budget. Our success in improving the CPI also depends on the public’s continued belief that our decisions about the construction of the index are arrived at independently and impartially, using the most appropriate techniques available to us. Preservation of that independence and impartiality should be important to all who depend upon the CPI.



Attachment A: Components Retaining the Arithmetic Mean (Laspeyres) Formula

Selected shelter services:
A) Rent of primary residence B) Owners’ equivalent rent of primary residence C) Housing at school, excluding board
Selected utilities and government charges:
A) Electricity C) Residential water and sewerage maintenance E) Telephone services, local charges
B) Utility natural gas service D) State and local registration, license, and motor vehicle property tax F) Cable television
Selected medical care services:
A) Physicians’ services C) Eyeglasses and eye care E) Hospital services
B) Dental services D) Services by other medical professionals F) Nursing homes and adult daycare