CPI retooling could result in big savings for Ottawa, business

Posted on February 13, 2012 in Governance Delivery System

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TheGlobeandMail.com – news/politics
Published Sunday, Feb. 12, 2012. Last updated Monday, Feb. 13, 2012.   Steven Chase  And Tavia Grant, Ottawa and Toronto

Canada’s statistics agency is refining the consumer price index, a key economic yardstick for matching pensions and salaries to the rising cost of living – and the result could mean sizable savings for governments and corporations that hike payments annually to keep pace with inflation.

Statistics Canada’s consumer price index, known as CPI, is a widely followed gauge of inflation that has an enormous impact on Canadians’ lives. It’s used to determine cost-of-living increases in people’s pay and pensions, as well as government benefits, such as old age security.

For years, however, some economists outside Statistics Canada have argued the consumer price index’s measure of inflation overestimates what’s happening – concerns that echo a longstanding debate in other countries, such as the United States.

Statistics Canada acknowledges that one kind of bias that creeps into consumer price tracking can add as much as 0.2 percentage points to the consumer-price-index measure of inflation – meaning that when inflation is measured at 2 per cent, the true rate would be 1.8 per cent.

The agency is more than 18 months into the CPI Enhancement Initiative, which attempts to improve the precision of its work. Statscan received extra funding to tackle the “measurement bias” – cash that rises to as much as $15-million in the fifth year of the effort – and make the index more attuned to Canadians’ spending habits.

The effort is under way as the Harper Conservatives try to squeeze savings out of government and trim expenses in order to balance the budget by 2015-16.

If Statscan is successful in reducing overestimation of consumer price inflation, then annual increases in public or private wages and pensions indexed to the CPI will end up smaller than they would have been.

This could mean companies have to pay out less in annual wage increases, but it will also offer some cost savings for Ottawa, economist and former Finance Canada official Don Drummond notes.

For instance, the federal government spends about $36-billion annually on old-age-security benefit payments and increases in the program are linked to the CPI index.

If Statistics Canada removes 0.2 percentage points of over-estimation in the inflation rate, then the annual cost-of-living rate increase for old-age security will be that much lower.

It would mean more than $72-million in savings the first year, and the benefits of the freed-up cash would accumulate annually – meaning its value would grow to $144-million in the second year and $216-million in the third.

While Canadians might complain about a reduction in the growth of their paycheques or pension payouts, Mr. Drummond said, they’re just losing what was never theirs: “You were being compensated for some inflation that never occurred.”

Some economists outside Statistics Canada talk of a much bigger over-estimation. A Bank of Canada economist estimated in 2005 that several kinds of “measurement bias” adds as much as 0.6 percentage points to the consumer-price-index reading of inflation – meaning that when inflation is measured at 2 per cent, the true rate would be 1.4 per cent.

Statistics Canada isn’t willing to embrace this economist’s estimate, but there’s a lot riding on producing a better gauge of consumer price inflation.

The Bank of Canada watches changes in the consumer price index to help decide whether it needs to take action to keep inflation on target. The amount of income Canadians are allowed to earn tax- free rises in connection with the index.

“We really need this measure to be as precise as it’s possible to be,” chief statistician Wayne Smith said in a recent interview.

Statistics Canada says it’s not concerned with how their fine-tuning might affect cost-of-living increases in wages or benefits or pensions. “We’re just trying to produce the most accurate statistic,” Richard Evans, director of Statscan’s consumer-prices division, said in an interview.

Statscan cautions that it does not expect to remove all the measurement bias in its readings.

Statistics Canada monitors the prices of a “basket” of about 600 goods and services purchased by consumers to keep track of increases in the consumer price index.

The main cause of measurement bias is the failure to change the makeup and weighting of items in the “basket” quickly enough to reflect shifting spending behaviour.

“In effect, we end up giving too much importance to the things whose prices are rising and not enough to the things whose prices are dropping,” Mr. Evans said.

Statistics Canada is switching gears to be more nimble, just as its counterparts in other countries have done as they struggle with the same measurement challenges.

It’s moving from updating and adjusting the basket of consumer goods and services every two years instead of every four years. The agency will eventually shift to revising it every year.

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