Will the Social Security COLA for 2023 be high enough?
Will the real inflation rate hold?
I ask because we are fast approaching the date when the Social Security Administration (SSA) will set the cost of living adjustment for 2023 Social Security checks. is the case nearly every year retirees wonder if the SSA is using the correct COLA factor.
We already know that since inflation is at its highest level in 40 years, next year’s COLA will be the highest in several decades. But whether it will be high enough to compensate retirees for the inflation they actually experience is a matter of intense debate.
Don’t bury my lead: I wouldn’t worry. The main contenders for the COLA adjustment factor each tell almost exactly the same story.
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It is helpful to begin this discussion with a review of the three main measures of inflation that are calculated each month by the federal government’s Bureau of Labor Statistics:
CPI-U. This is the overall inflation figure published each month by the financial press. It stands for “Consumer Price Index for All Urban Consumers”.
CPI-W. This is the version of the CPI that SSA is required by law to use for its COLA calculations. It is officially known as the “Consumer Price Index for all urban wage and office workers” (CPI-W), and compared to the CPI-U, it “gives a slightly higher weight food, clothing, transportation and other goods and services,” according to the Bureau of Labor Statisticsand “a slightly lower burden on housing, medical care and recreation”.
CPI-E. It stands for “Consumer Price Index for Seniors” and the SSA calculates it by taking into account the different spending habits of the typical senior. Many Social Security reform proposals in Congress include a requirement that, in the future, the SSA will use this version of the CPI to adjust for inflation.
The Covid-19 pandemic has introduced an additional factor into these discussions, since consumer habits have changed significantly since the economy was locked down in early 2020. Because the CPI calculation is based on pre-Covid assumptions about the relative proportions of household budgets that are spent on food, transport, housing, etc., it is possible that pandemic-induced changes in consumption patterns have made the CPI a poor measure of real pensioner inflation.
Although the SSA does not calculate a separate CPI that reflects Covid-19-induced changes in our spending habits, the one that has is Alberto Cavallo, professor at Harvard Business School. In the 12 months to May 2020, for example, its “Covid-CPI” increased 0.8 percentage points more than the CPI-U.
Little real difference
Although there is much theoretical debate about the relative merits of these various measures, they have made little difference in recent years. Consider first the three CPI measures from the Bureau of Labor Statistics, which over the past 15 years have reported nearly identical annualized inflation rates: CPI-U is 2.38%, l CPI-E is 2.39% and CPI-W is 2.44. %.
Cavallo’s Covid-CPI doesn’t go back 15 years, so I don’t have comparison data over that longer period. But after the months in 2020 when the CPI underestimated inflation, according to Cavallo’s most recent measures, the CPI in 2021 and 2022 overestimated it. The net result is that the four-year annualized return of its Covid-CPI is very similar to those of other CPI measures.
The attached chart plots, for each month since the start of 2019, the 12-month rates of change for the four measures of inflation. Note that, over the 12 months to June, the last month for which Cavallo calculated its Covid-CPI, it increased by 8.51%, CPI-E by 8.46%, CPI-U by 9 .00% and the CPI-W of 9.81%.
This means that the COLA adjustment factor that the SSA will use to compile next year’s checks – the CPI-W – shows the highest rate of inflation of these four.
We do not yet know the exact inflation adjustment factor that will be used for 2023, as it will not be fixed until the September inflation figures are released in early October. But, for now, each of the different inflation indices tells a largely similar story. And, to the extent that there is a difference between these indices, the one SSA uses will result in the largest COLA.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at email@example.com.