Explain the CPI bias and how it can distort private contracts and increase government outlays

What will be an ideal response?

The CPI bias is the point that the CPI overstates the true inflation rate. The amount of the bias has been estimated at 1.1 percentage points per year. Thus when workers sign a contract that links their wages to the CPI in order to adjust the wages to offset inflation, the adjustment is too large. Wages rise by more than is necessary to keep pace with inflation. Thus a contract that might have been designed to keep workers "even" with inflation is distorted so that workers actually gain. Similarly, many government outlays, such as social security, are linked to the CPI. Thus the adjustment in these expenditures exceeds the amount necessary for inflation, and hence the amount of the government's outlays increases by more than is appropriate for inflation.