The Choice of Price Indexes Can Matter
I recently ran across a
reference to a BLS study looking at the divergence of real wages and labor
productivity growth over the past 30 years, and I decided to look at one aspect
of it. The study uses the Consumer Price
Index (CPI) to deflate wages and the NonFarm Business Output Price Deflator
(NFBODef) to deflate the value of nonfarm business output. There is an alternative index for consumer
prices, the Personal Consumption Expenditure Deflator (PCEDef), and I wondered
if we would see (essentially) the same pattern if we used that measure of
consumer prices instead of the CPI. Let
me anticipate my conclusions. Between
1947 and 1978, there was little divergence in the rate of increase in prices
regardless of which measure one chose to use.
But from 1978 to 2012, the rate of inflation calculated using the CPI
has been noticeable faster, and thus real wage growth has been noticeable
slower, when calculated using the CPI than when using either of the other two
price indexes.
It took me a while to figure
out how to put all three indexes on the same chart. For one thing, the CPI has a base period of
198284, while the PCEDef and the NVBODef share 2005 as a base period. As a result, they have markedly different
starting values in 1947. What I finally
did was start all three indexes at the same value (about 15) at the beginning
of 1947 (January 1947 for the CPI and 1947.Q1 for the other two) and then
changed then at the periodtoperiod rate of change calculated from the
original indexes. Then I converted all
three index values to natural logarithms.
This gave me the following chart.
Click to enlarge.
CPI Inflation

PCE Inflation

NFBO Inflation
 
19472012

3.6%

3.2%

3.1%

19471978

3.5%

3.3%

3.4%

19781990

5.9%

5.3%

4.6%

19902012

2.5%

2.1%

1.8%

Remember that I scaled all three price indexes so that
they begat at the same value. By the end
of 1978 (see the table below), the PCEDef was 3.6% below the NFBODef, while
the CPI was 4.9% higher. But over 31
years, neither of these difference seems particularly notable. By 1990, the PCEDef was 3.6 higher
than the NFBODef—but the CPI was 36.4% higher. The divergence over that 12year period was significant. And by 2012, the CPI was 40.7% higher, while
the PCEDef was about 7.9% higher. So the
essential period of divergence was from 1978 to 1990, when the CPI rose (as can
be seen in the table above) considerably more rapidly than the other two price
indexes.
PCEDef/NFBODef

CPI/NFBODef
 
End of 1978

3.6%

+4.9%

End of 1990

+3.6%

+36.4%

End of 2012

+7.9%

+40.7%

The problem, however, is simple. The degree of divergence between growth in real
wages and the growth in the value of real nonfarm business output growth will
be strikingly different if we use the PCE deflator or the CPI. The following chart shows median real weekly
earnings, with nominal wages deflated by the PCE deflator, on the one hand, and
by the CPI on the other. (The readily
available data series on earnings is available from the BLS only back to 1979;
however, since the primary divergence of the price indexes dates from 1978,
this should not be that much of a problem.)
At the beginning of 1979, real wages calculated by using the CPI were 8%
below real wages using the PCE deflator; by 2004, that gap had widened to 20%,
and has been roughly unchanged since (at the end of 2012, it was 21%). To put it another way, between 1979 and 2012,
real median weekly wages calculated using the CPI rose by 4%. Using the PCE deflator, they rose by 15.5%. (In either case, average annual wage growth
has been slow—0.1% per year if
calculated using the CPI and 0.4% using the PCE deflator.)
Click to enlarge
This is not the place (or the time) to get into why the
CPI and the PCE deflator have varied so much over the past 35 years. But they have varied. And that variation matters quite a bit.