US inflation rate could be overstated by 1.1%

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The Independent Online
US government statistics may be heavily overestimating the country's rate of inflation, and a correction could slash tens of billions of dollars off the country's annual budget deficit and simultaneously boost the chances of a political deal for a balanced federal budget.

According to a report to Congress by an authoritative independent commission yesterday, the consumer price index (CPI) overstates the real inflation rate by 1.1 percentage points. In other words, US inflation is running at not just under 3 per cent a year, but little more than 1.5 per cent. For the public finances, the consequences of such an adjustment would be momentous.

Social security payments, geared to the CPI, would rise less rapidly, as would inflation-linked income tax deductions and exemptions, meaning that the Treasury's tax take would be higher. Higher receipts and smaller outlays would reduce the federal borrowing requirement.

In all, calculates the commission headed by Michael Boskin, a former chief economic adviser to President Bush, a change in the index could cut the federal deficit by $60bn (pounds 37bn) by 2002, the target year of both democratic and Republican plans for a balanced budget. On present trends, that year's deficit is put at between $150bn and $200bn.

Doubts about the validity of the CPI have long been voiced here by no less than Alan Greenspan, Federal Reserve Board chairman, among others. There is a growing view that the structure of the CPI does not take sufficient account of ever fiercer competition in the economy, and the tendency of consumers to buy cheaper alternatives if a particular item covered in the index becomes more expensive. But the latest finding could not be better timed for the balanced budget lobby.

Not only was the US deficit of $106bn in fiscal 1996 the lowest in 20 years (and at 1.6 per cent of GDP the most respectable of any large industrial country), but the political landscape is favourable for a bipartisan budget agreement within the next 12 to 18 months.

Even before yesterday's report, the gap between Republican and Democratic budget blueprints had shrunk to a total of $148bn over the five years until 2002. An enlarged Republican majority in the Senate makes it more likely that a constitutional amendment to balance the budget will clear Congress in 1997, giving both sides political cover to strike an agreement.