Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / How a New Inflation Measure Might Change Your Paycheck
Transcript
- Lucas: So Luna, you know the monthly ritual—the CPI report drops, and we scan for the headline number, the core number, and then we decide whether to panic or shrug. But this past Wednesday, when the July CPI came in, there was a quiet detail buried in the release that’s actually a bigger deal than the 0.2 percent move in the index. Luna: You’re talking about the chained CPI, right? The version that adjusts for how we swap out pricier items for cheaper ones. Lucas: Exactly. The Bureau of Labor Statistics publishes it as a supplemental index, but for the first time in years, it’s starting to get real attention because of what it could mean for your paycheck. If you’re on Social Security or a federal pension, or if you’re just negotiating a raise, this index might silently shrink next year’s cost of living bump. Luna: And that’s the kind of thing that sneaks up on people. I mean, most of us just look at the headline CPI and assume that’s our inflation. Lucas: Right, and the gap between the two is widening. In July, the standard CPI was 332.8, up from 332.57 the month before. Core CPI, which strips out food and energy, hit 336.8. But the chained CPI, which we don’t get in that same release, tends to run about two-tenths of a percentage point lower over a year. It’s a small difference, but when you compound it over a decade, it really adds up. Luna: So what exactly is the chained CPI doing differently? I’ve read that it accounts for substitution—like, if beef gets too expensive, you switch to chicken. Lucas: That’s the core idea. The traditional CPI assumes you keep buying the same basket of goods every month, even if prices change. So if steak spikes, the index goes up as if you’re still buying the same amount of steak. The chained CPI, on the other hand, recognizes that when steak gets pricey, you might buy chicken instead. It’s a more realistic measure of how consumers actually behave, which is why it usually shows a slower rate of inflation. Luna: And that’s also why it’s so politically sensitive. If the government switches to the chained CPI for cost of living adjustments, benefits would grow more slowly over time, saving the Treasury billions. Lucas: Exactly. There have been proposals to use the chained CPI for Social Security and federal pensions, and they’ve been controversial. But this isn’t just a policy debate—the chained CPI is already used for some tax brackets and for calculating the federal poverty level. And it’s the kind of thing that could matter for your own budget planning, too, because it tells you something about how the government measures inflation when it decides on those annual adjustments. Luna: So if you’re a retiree relying on Social Security, a two-tenths difference in the inflation rate could translate to a smaller monthly check next year, right? Lucas: It could. Social Security benefits are adjusted each year based on the CPI for Urban Wage Earners and Clerical Workers, which is a different index from the headline CPI. But if Congress ever switched to the chained version, that would trim the annual increase by a small amount. Over 20 years, that could mean thousands of dollars less in cumulative benefits. It’s the kind of thing that sounds minor but has real consequences. Luna: And you know, this is exactly the kind of nuance that we love to dig into on this show. And I think it’s worth mentioning that if you enjoy these deep dives, you can help keep the podcast ad-free by supporting us on buy me a coffee dot com slash fexingo. It’s those small contributions that make this independent analysis possible. Lucas: Yeah, we appreciate that. But let’s get back to the chained CPI, because there’s another layer here. The gap between the chained and the standard CPI isn’t constant—it widens when prices are volatile and consumers switch more aggressively. So in a year like this, with food and energy swings, the difference could be bigger than the historical average. Luna: How big could that gap get? I remember you mentioned that the 10-year breakeven inflation rate is around 2.27 percent, which suggests the market expects modest inflation. But that’s the standard CPI number, right? Lucas: Right, the breakeven is based on the headline CPI, not the chained. But if you think about it, the chained CPI might be a better predictor of what households actually experience, because it captures the substitution effect. And that’s why some economists argue that the Fed’s 2 percent target should be based on the chained measure, not the standard one. That would mean they might hold rates lower than the current 3.63 percent effective federal funds rate. Luna: Interesting. So the Fed’s preferred measure is actually the PCE price index, which already accounts for substitution to some extent. And that index came in at 131.4 in June, down from 131.53. So it’s already running cooler than the CPI. Lucas: Exactly. The PCE is the Fed’s go-to, and it’s been showing slower inflation than the CPI for a while now. In fact, core PCE is up only 0.2 percent from the previous month, while core CPI is up a bit more. That’s one of the reasons why the Fed feels comfortable holding rates steady, even though consumers are still feeling price pressure in certain categories. Luna: So if the Fed is looking at PCE, why should we care about the chained CPI at all? It’s not like it’s the official measure for monetary policy. Lucas: Because it affects your wallet directly in ways that the PCE doesn’t. For example, if you’re eligible for Supplemental Nutrition Assistance Program, or SNAP, the benefit amounts are tied to the Thrifty Food Plan, which is updated using the CPI, but there’ve been proposals to use the chained CPI there too. And for federal tax brackets, the chained CPI is already used to adjust for inflation, which means your tax brackets creep up more slowly, and you might end up paying a bit more in taxes over time. Luna: That’s a sneaky one. I didn’t realize tax brackets already use the chained CPI. Lucas: Yeah, since 2017, the IRS has used the chained CPI for inflation adjustments to tax brackets, standard deductions, and things like the annual gift tax exclusion. So when you hear that the chained CPI is lower, that means the income thresholds for each tax bracket rise more slowly. If your income grows at 3 percent but the bracket threshold only rises 2.8 percent, you might end up in a higher bracket without actually getting a real raise. Luna: That’s a real paycheck impact. So it’s not just about retirees—it’s about anyone who works and pays taxes. Lucas: Precisely. And that’s why the July CPI report is more than just a number. The headline showed a slight uptick, but the underlying story is that the chained CPI and the PCE are both running cooler, which feeds into policy decisions that shape your cost of living. And with the budget deficit surging to its highest level since March 2021, there’s more pressure on the government to find savings, and switching to the chained CPI for benefit programs could be one of those levers. Luna: So do you think that switch is likely? I know it’s been a political hot potato for years. Lucas: I think it’s one of those ideas that keeps resurfacing because it’s a way to trim spending without cutting benefits outright. But it’s also politically risky, because the savings come out of the pockets of the most vulnerable people—the elderly, the disabled. I’ve seen estimates that switching to the chained CPI would reduce the average Social Security benefit by about 3 percent by age 85. That’s a big deal for someone living on a fixed income. Luna: But at the same time, some economists argue that the chained CPI is actually more accurate, so it’s not just a budget gimmick. Lucas: That’s true. It reflects real behavior, and if you measure inflation the way people actually live, you get a truer picture. The problem is that it doesn’t account for the fact that substitution often means a decline in quality of life—you’re not buying the same item, you’re buying a cheaper alternative, and that’s not always a perfect substitute. So there’s a philosophical debate about whether a lower inflation number is really a good thing if it means people are making painful trade-offs. Luna: And that’s the human side of inflation that’s hard to capture in a single index. I’m thinking of that story about lettuce prices plunging because of a cyclospora scare—that’s not a substitution you’d choose, that’s just a safety issue. Lucas: Right, and that’s a good example of how price movements don’t always reflect normal consumer behavior. The chained CPI assumes you’re switching because you want to save money, not because a food safety scare makes a product unavailable. So in times like that, the chained CPI might understate how much your cost of living actually rises, because you’re not choosing to buy the cheaper alternative—you’re forced to. Luna: So what’s the takeaway for our listeners? Should they be watching the chained CPI more closely? Lucas: I’d say yes, especially if they’re planning for retirement or trying to negotiate a salary increase based on cost of living. The headline CPI is what you see on the news, but the chained CPI is what goes into tax brackets and some benefit calculations. And if you’re on the verge of a raise, knowing that your real wage growth is better measured by the chained CPI could help you make the case for a bigger bump. Luna: And if you’re an investor, how does this factor into your decisions? Lucas: Well, the chained CPI is one of the reasons why the bond market might expect lower inflation over the long term—the breakeven rate is only 2.27 percent, which is below the recent CPI readings. If you believe the chained CPI is a more accurate predictor, then that 2.27 percent might be closer to reality than the 2.4 percent headline CPI you see in the monthly reports. That has implications for bond yields, and for stocks, too, because lower inflation means the Fed is less likely to hike rates, which supports equity valuations. Luna: So in a way, the chained CPI is a quieter but more honest measure of inflation, even if it’s not the one that grabs headlines. Lucas: Exactly. It’s the kind of indicator that doesn’t move markets on its own, but it shapes policy and your personal finances in meaningful ways. And next time you hear about the CPI, I’d encourage you to ask not just what the number is, but which index they’re talking about—because it could make a difference in your planning. Luna: And if you want to keep exploring these kinds of topics with us, you know where to find us. But for now, thanks for joining this conversation. We’ll see you next time.