Will real inflation please stand up?
I ask because we are fast approaching the date when the Social Security Administration (SSA) will determine the cost of living adjustment for the 2023 Social Security checks. So it is to be expected that, as is the case every year now, retirees will question whether the SSA is using the correct COLA factor.
We already know that as inflation has hit its highest point in 40 years, next year’s COLA will be the highest in decades. But whether it will be high enough to compensate retirees for the inflation they actually incur is hotly debated.
Not to bury my lead: I wouldn’t worry. The top contenders for the COLA adjustment factor each tell almost exactly the same story.
Read: Medicare beneficiaries – here’s the help you’ll get from the Inflation Reduction Act in the New Year and in the Future
It’s helpful to start this discussion with an overview of the three primary measures of inflation calculated each month by the federal government’s Bureau of Labor Statistics:
CPI-U. This is the overall inflation rate reported by the financial press each month. It stands for “Consumer Price Index for All Urban Consumers.”
CPI-W. This is the version of the CPI that the SSA is required by law to use for its COLA calculations. It is formally known as the “Consumer Price Index for all urban wage earners and white-collar workers” (CPI-W), and compared to the CPI-U, it “puts a slightly higher weight on food, clothing, transportation and other goods and services”. according to the Bureau of Labor Statistics, and “a slightly lower weight on housing, medical care and recreation.”
CPI-E. This stands for “Consumer Price Index for the Elderly,” and the SSA calculates it by taking into account the different spending habits of the typical older person. Many of the Social Security reform proposals in Congress include a requirement that the SSA use this version of the CPI to adjust inflation in the future.
The Covid-19 pandemic has introduced an additional factor to these discussions, as spending patterns have changed significantly since the economy shut down in early 2020. Because the calculation of the CPI is based on pre-Covid assumptions about the relative proportions of the family budget spent on food, transportation, housing, etc., it is possible that pandemic-induced changes in spending patterns have made the CPI a poor measure. for the actual inflation of retirees.
While the SSA doesn’t calculate a separate CPI that reflects the changes in our spending habits caused by Covid-19, Alberto Cavallo, a professor at Harvard Business School, is one that does. For example, in the 12 months to May 2020, its ‘Covid-CPI’ rose by 0.8 percentage points more than the CPI-U.
Little actual difference
While there is much theoretical debate about the relative merits of these different measures, they have made little difference in recent years. First, consider the Bureau of Labor Statistics’ three CPI metrics, which report nearly identical annual inflation rates for the past 15 years: the CPI-Us is 2.38%, the CPI-Es is 2.39%, and the CPI-Ws is 2.44%.
Cavallo’s Covid-CPI doesn’t go back 15 years, so I don’t have comparative data for it over this longer period. But after the months in 2020 when the CPI underestimated inflation, according to Cavallo’s more recent measurements, in 2021 and 2022 the CPI overestimated it. The net result is that the four-year annual return of its Covid CPI is very similar to that of the other CPI metrics.
The accompanying chart shows the 12-month lag of the four inflation measures for each month since early 2019. Note that over the 12 months through June, the last month for which Cavallo calculated its Covid-CPI, it rose 8.51%, the CPI-E 8.46%, the CPI-U 9.00% and the CPI-W 9.81%.
This means that the COLA adjustment factor that the SSA will use to set next year’s controls — the CPI-W — shows the highest inflation of these four.
We do not yet know the exact inflation adjustment factor that will be used for 2023, as it will not be determined until September inflation figures are published in early October. But for now, each of the various inflation indices tells a largely similar story. And to the extent that there is any difference in those indices, the one using SSA will result in the largest COLA.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings keeps investment newsletters that pay a fixed fee to be audited. He can be reached at [email protected].