Personal and Impersonal

The lead story in the Money and Investing section of the Wall Street Journal had an ominous headline that immediately caught my attention. It didn’t rise to the level of war and peace issues or life and death issues but for me it mattered tremendously. The headline stated “Chocolate Prices Soar in Dark Turn” and the article focused on two key factors responsible for the substantial increase in chocolate/cocoa prices. The first reason for the price increase is weather related and caused by dry weather reducing the harvest. The second is changing taste with more consumers developing a taste for dark chocolate in place of milk chocolate. So, in summary the price increase is related to both supply and demand factors; over time the supply issues will likely improve while the increased demand could continue (my prediction) or moderate.

Under full disclosure, I have been a long time chocolate fan and my preference has always been for dark chocolate, typically chocolate that contains 70% or slightly more cocoa solids. Milk chocolate does remind me of my childhood. The taste is milder and creamier and if there are nuts or crisps included, those flavors are more prominent. But I prefer good taste now to reminiscing; I do buy milk chocolate now and then but never get the satisfaction that a good piece of dark chocolate provides.

Consumer price index/cost of living increases are often difficult concepts for college students (and others) to relate to. If what triggered the increase has no direct tie to them or their families, the concept seems separate from their reality and not particularly meaningful. My response in class has been to assign students to develop their own consumer price index. Students put together their own market basket based on their own regular expenditures and track cost increases for that market basket. They also note whether increases in costs trigger substitutions of one product for another. For example, the increase in chocolate prices could trigger substituting milk chocolate for dark chocolate since the price increases are more moderate for milk chocolate, or could trigger substituting vanilla or butterscotch for chocolate. For some, the level of satisfaction wouldn’t change with this substitution; for others, like me, the thought of these substitutions is depressing.

An individual’s consumer price index is an effective educational tool for increasing comprehension of a price index. The next challenge is to demonstrate that increases in the national or regional CPI which don’t directly impact you are still extremely important. Often, if it doesn’t touch you directly, it doesn’t seem to matter. However, increases in health care costs now may not have an immediate or short term impact your cost of living. You employer may cover these increases or your health care plan may have short term fixed monthly payments. Increases in gas prices, may not short term affect a mass transit rider. Even if these increases aren’t personal for you, it pays to be fully informed and plan for the future impact.

It is likely that I will adjust to the changing chocolate prices by increasing my expenditures for chocolate. It is also clear to me that we should be increasing economic literacy at all levels.

Chained

A chained CPI (Consumer Price Index) sounds like a very painful condition. Or it sounds like a price index that couldn’t be controlled and is therefore forcefully restrained. Thankfully, it is neither of these situations and is instead a more realistic way of assessing cost of living increases. As a small scale example, assume that the price of broccoli increases dramatically. If you assume that you will buy the same amount of broccoli as before, the impact of this price escalation will be far greater than if, given the broccoli price increase, you move decisively into having more green beans as part of your diet. In reality we make substitutions as prices of certain products escalate in comparison to other products. I have been very careful in my example, not to use dark chocolate because for a true chocolate lover it is inconceivable to substitute out of chocolate.

As Washington continues to grapple with sequestration, the White House is proposing limited cost of living increases in indexed social programs by substituting the chained CPI for the set market basket CPI presently in use. I think this makes sense. We do substitute, when possible, out of products that have increased in price to products that serve the same purpose but are more reasonably priced. And the impact is to moderate the price increase for our (slightly) revised market basket.

Any alternative we can contemplate to the present rigid sequestration formula will require spending reductions along these lines. The Simpson Bowles Moment of Truth Project has endorsed moving to a chained CPI. Given the impact of the CPI on Social Security and other benefits, their estimate is that this more accurate measure of inflation “would save $390 billion over a decade - $215 billion from spending, $125 billion from revenue, and $50 billion from interest savings.” They also estimate that the second decade savings “would reduce the deficit by over $1 trillion…” and “would reduce Social Security’s 75-year funding gap by one-fifth.” A chained CPI is also considered, for the most part, to be “distributionally neutral” with a similar percentage impact across various income levels.

The chained CPI proposal has the endorsement of not only the White House but also of the House of Representatives leadership. Where there are still differences is what will accompany the chained CPI In the deficit reduction legislation – will it be further cuts in spending or will it be further increases in taxes. Both parties are in a difficult position in regard to this issue. The Republicans would be hard pressed to support an additional tax hike and the Democrats would be hard pressed to reductions in benefits without further tax increases. But to the extent that each party will have to move so that this key part of any solution falls into place, we should have that movement now so that the economic recovery is the clear beneficiary and we have moved forward in a most meaningful way in reducing the deficit.