“Did you adjust for inflation?” An occupational inconvenience of doing economic research is that you are routinely asked by disbelieving non-researchers whether your numbers have taken into account the rising cost of living. The answer to that question is nearly always, “Yes.” The debates among researchers are about how to adjust earnings and income for inflation, and specifically which price index to use.
These debates have significant implications for policy and our understanding of economic challenges. Last week, the Census Bureau announced it will use a new price index to adjust past earnings and income estimates that will be more accurate and, as such, a better tool for policymakers. It’s bigger news than it might seem.
If nominal income rises by 5 percent but prices rise by 4 percent, then “real” income (adjusted for inflation) rises only by approximately 1 percent. But knowing how much prices have risen requires a well-measured price index. Put simply, a price index looks at a changing set of goods and services that is intended to provide a constant level of satisfaction or well-being over time. This set of goods and services reflects items purchased by the typical American consumer.
Researchers have several options to choose from when looking for a price index, which go by different clumsy acronyms. Every month, the Bureau of Labor Statistics (in the Labor Department) publishes the Consumer Price Index (CPI-U) and the Bureau of Economic Analysis (in the Commerce Department) publishes the Personal Consumption Expenditures (PCE) price index. These are the inflation measures that policymakers, consumers, businesses, and investors monitor carefully.