Cola spinning. (Investments & Finance).

WITH little fanfare, the Bureau of Labor Statistics introduced an alternative consumer price index, along with the old CPI we have come to know and love. While the CPI rose 1.5 percent in the 12 months ended July, the new "chained" CPI for all urban consumers, or C-CPI-U, registered a smaller 1.1 percent increase.

When one considers that 30 percent of all government expenditures have a cost-of-living adjustment attached to them, the 0.4 percentage-point difference between the two indexes starts to be a big deal.

The C-CPI-U does away with a fixed-basket approach to measuring inflation and instead will capture the substitution effect, as consumers respond to relative price changes and buy cheaper items in place of more expensive ones.

The new index measures consumers' cost of living, not inflation, which seems to please policy makers just fine. Now that budget deficits are an issue again, the government may be looking for ways to pare expenditures, just as it did in the mid-1990s when it adopted the recommendations of the Boskin Commission.

The congressionally appointed panel, under the leadership of Michael Boskin, the first President Bush's chairman of the Council of Economic Advisers, reported in 1996 that the CPI overstated inflation by 1.1 percentage points. The changes recommended by the commission were expected to shave almost $150 billion off federal expenditures over the next 10 years.

Back then, official budget projections "still anticipated years and years of deficit spending," says Lou Crandall, chief economist at Wrightson & Associates. "Eliminating the overstatement in the CPI seemed a tempting way to narrow the projected budget gap."

Is the new CPI, once it has some statistical history, on its way to becoming the standard for COLAs now that deficits are an issue again?

Another downshift in cost-of-living adjustments would be a blow to the old folks, who don't spend heavily on ever-cheaper computers but instead devote a good portion of their income to expensive health-care services and medications.

"A product-based cost-of-living index doesn't reflect the cost of living for health care" says Pete Davis, president of Davis Capital Investment Ideas in Washington. "That's why a lot of senators are finding out they can't go home without passing a prescription drug benefit."

As it happens, the BLS maintains a consumer price index for the elderly, defined as those 62 years of age or older. Despite the greater weighting on services for the elderly, the old-folks CPI typically runs just 9.2 or 0.3 percentage points higher than the regular CPI on a 12-month basis.

For the year ended July, the OF-CPI-U was up 1.7 percent versus 1.5 percent for the CPI. Any effort by the government to reduce spending with a COLA component faces two hurdles, in addition to the powerful lobbying effort of the AARP.

Policy makers may rely on the PCE price index when it comes to touting its inflation credentials. They still have to use the CPI when it comes to Social Security and other retirement programs, however.

A bigger obstacle to adopting the C-CPI-U for COLAs is the nature of the index itself: consumer expenditure data are available only with a lag. The BLS relies on the Census Bureau's Survey of Consumers and the final 2002 expenditure data won't be available until July 2003.

The old folks can rest easy for now. It's not that the government wouldn't like to reduce its paint-by-numbers expenditures. It's just that inflation is so low as to make overcoming the hurdles more effort than it's worth. But don't think that the administration and Congress won't resurrect the idea of the CPI as quick budgetary fix once the cycle turns.