A Convenient Redefinition

Prior to 1980, CPI was calculated using a relatively simple and straightforward approach: a fixed basket of goods and services that reflected what the average American household consumed. This method ensured that inflation measurements closely aligned with the actual rising costs experienced by consumers. However, as inflation soared in the late 1970s, the cost of government programs tied to CPI—such as Social Security, federal pensions, and other indexed benefits—began to rise dramatically. This created significant pressure to tame official inflation rates, not necessarily to reflect true consumer costs, but to ease the financial burden on the government.

In response, several key changes were introduced that had the effect of lowering reported inflation rates:

1. Substitution Effect: Prior to 1980, CPI calculations assumed a fixed basket of goods, meaning that if the price of steak rose, it was recorded as inflation. However, in the 1990s, the Bureau of Labor Statistics (BLS) introduced the geometric mean formula, which assumed that if steak became too expensive, consumers would switch to chicken. This allowed the index to register lower inflation, even though consumers were forced to downgrade their standard of living.

2. Hedonic Adjustments: The BLS also introduced "hedonic quality adjustments," which assume that if a product improves in quality (such as a computer with better processing power), its price increase isn’t purely inflationary but partially a reflection of better value. While this may make sense in theory, in practice, it allows inflation to be understated, as these adjustments don’t account for the fact that consumers still have to spend more money to acquire these goods.

3. Owner-Equivalent Rent (OER): One of the most impactful changes was the 1983 shift in how housing costs were measured. Instead of using actual home prices and mortgage payments—both of which were soaring—the BLS replaced them with "Owner-Equivalent Rent" (OER), an estimate of what homeowners would theoretically pay to rent their own homes. Since rent typically rises more slowly than home prices, this significantly slowed the reported rate of housing inflation—even when real housing costs were skyrocketing.

The Real Motivation: Cutting Government Costs

Why make these changes? The answer is simple: government budgets. The higher the official inflation rate, the more the government is required to pay out in Social Security, federal pensions, and other COLA-tied programs. By modifying how inflation was measured, the government could artificially suppress reported inflation, reducing long-term liabilities while claiming they were simply making CPI more accurate.

The 1996 Boskin Commission, tasked with evaluating CPI measurement, estimated that the index was overstating inflation by about 1.1% per year. Their recommendations led to further modifications, which conveniently resulted in lower COLA increases for Social Security recipients and slower growth in federal spending overall. If CPI had remained calculated using pre-1980s methods, Social Security checks today would likely be significantly higher, and tax brackets would have been adjusted more aggressively, reducing the government's tax revenues.

How Has This Affected Consumers?

The consequences of these changes have been profound. For retirees and those on fixed incomes, the real purchasing power of Social Security benefits has been eroded over time. While official CPI statistics claim inflation is modest, real-world costs—especially for essentials like housing, healthcare, and food—have outpaced these artificially low adjustments.

Moreover, wage adjustments for many workers are based on CPI, meaning that salaries have lagged behind real inflation, reducing the standard of living for millions. The perception that inflation is under control also affects interest rate policies and financial markets, often leading to asset bubbles that further distort economic reality.

The Bottom Line: CPI Is a Political Tool

Ultimately, CPI is not just a neutral economic statistic—it is a political tool. While the official rationale for these methodological changes was to make inflation measurements "more accurate," the practical effect has been a slow-motion erosion of real income and benefits for average Americans. The changes to CPI have allowed policymakers to claim inflation is under control while systematically under-reporting the true rise in living costs.

The next time you hear an official CPI number that seems out of touch with reality, remember: it's not your imagination. The game was rigged decades ago.

Inflation is a complex economic phenomenon that can disrupt stability, erode purchasing power, and hinder economic growth.

Understanding its causes and consequences is crucial for policymakers and individuals alike, as it influences decisions related to spending, investment management, and so many other matters.