A. General Cost-Effectiveness Analysis Issues
3. How do I adjust for the effects of inflation?
Economic analysis requires costs to be expressed in 'real dollars.' That is, they must be adjusted for inflation so that values from different years are expressed in terms of a single year's currency. When this is not done the values are said to be in 'nominal dollars.'
Inflation adjustments are made using price indices. Each index consists of numbers representing the price level in each year relative to a base year. Some indices have values that correspond to shorter periods as well, such as months or quarters. What distinguishes the indices is how the price levels are established.
To correct for inflation you must select the base year to use as a common denominator. This is often the most recent year or the final year of study data. For example, suppose that you adjust for inflation using the Consumer Price Index for all items and all urban consumers. To express a 2000 cost in 2005 dollars, simply multiply the cost by the 2005 index and divide by the 2000 index. If the cost were $20 in 2000, this would be the calculation:
$20.00 x (96.88/85.42) = $20.00 x 1.1342 = $22.68
Converting costs to real dollars allows us to compare costs incurred in different years. For example, which is more expensive in 2005 dollars: A, which costs $20 in 1995, or item B, which costs $23 in 2000? Using the CPI for all items and all urban consumers, item B is more expensive in real terms: it costs $26.09 in 2005 dollars, whereas item A costs only $25.63 in 2005 dollars.
One can convert costs to any year for which a price index exists. The base year does not affect which good is more expensive. If A is more costly than B in one base year, it will be more costly in terms of any other base year.
Which Index?
At HERC we often use the U.S. Consumer Price Index for all items for all urban consumers. Values for this index tell what a market basket of consumer goods that cost $100 in 1983 would cost in the year in question. It quantifies the erosion of purchasing power by inflation. If most of the costs you are considering derive from staff, as is often the case for health care, then the general CPI is appropriate. The chain-weighted CPI is likely to be more accurate than the standard CPI, but it has only been figured since 2000.
We do not recommend using the Consumer Price Index for medical care. It analyzes changes in the cost of providing a day of stay and an outpatient visit. In recent years fewer but more expensive days of stay and visits are needed to treat an illness. This change is captured by the index without considering the change in productivity, overstating the increase in cost. Other faults of the medical care CPI are its reliance on list prices, and the weighting of component medical care goods and services based on consumers out-of-pocket costs rather than overall health care expenditures. Berndt et al. (2000) provide a more through discussion of shortcomings in the medical care CPI and propose a fundamental reform of it.
Index Values
The table below shows the 1993-2006 index values for three common inflation indices used for health care research.
| Table 1. Inflation Index Values | ||||
| Year | All-Item CPI | Chain-Weighted All-Item CPI |
GDP Implicit Deflator |
Health Services PPI |
|---|---|---|---|---|
| 2006 | 100.00 | 100.00 | 100.00 | * |
| 2005 | 96.88 | 97.26 | 97.28 | * |
| 2004 | 93.70 | 94.53 | 94.79 | * |
| 2003 | 91.27 | 92.22 | 93.09 | 100.00 |
| 2002 | 89.24 | 90.33 | 91.57 | 96.06 |
| 2001 | 87.85 | 89.22 | 91.57 | 93.64 |
| 2000 | 85.42 | 87.25 | 91.57 | 90.75 |
| 1999 | 82.64 | * | 91.57 | 88.42 |
| 1998 | 80.85 | * | 91.57 | 86.65 |
| 1997 | 79.61 | * | 91.57 | 85.36 |
| 1996 | 77.83 | * | 91.57 | 84.15 |
| 1995 | 75.60 | * | 91.57 | 82.38 |
| 1994 | 73.51 | * | 91.57 | * |
| 1993 | 71.68 | * | 76.03 |
* |
* The index was not calculated for this year.
Sources
R.J. Ozminkowski (personal communication)
Bureau of Labor Statistics, U.S. Department of Labor (http://www.bls.gov/cpi/home.htm)
Bureau of Economic Analysis, U.S. Department of Commerce (http://www.bea.gov/national/index.htm#gdp)
The Chain-Weighted All-Item CPI differs from the standard All-Item CPI in that the weights assigned to goods in the index change over time. The higher index number in 2000 indicates that the chain-weighted index yields slightly lower inflation rates than the older All-Item CPI in the period 2000-2006. The GDP Implicit Deflator, another common inflation measure, yields a 2000-2003 inflation rate between those of the two CPI indices. The Health Services Producer Price Index, a measure of inflation in prices paid by producers (rather than consumers), shows a much higher rate of inflation over the period 2000-2003. Over the nine-year period 1995-2003, however, it is nearly identical to the All-Item CPI.
The Health Services PPI is no longer produced. In January, 2004, the US Bureau of Labor Statistics changed to the North American Industrial Classification System. Among the dozens of health-related PPI classifications are “General medical and surgical hospitals,” “Medicare patients,” and “Diseases and disorders of the nervous system.”
What About Discounting?
If you are comparing two interventions, each involving a series of expenditures over time, you need to consider the time value of money (the fact that a dollar spent today is a bigger expense than a dollar spent a year from now). This requires application of a discount rate. The Public Health Service Panel on Cost-Effectiveness in Medicine recommends a discount rate of 3% (Lipscomb et al., 1996). To find the incremental cost-effectiveness ratio, the discount rate should be applied to both real costs and to outcomes measured as quality-adjusted life years.
Discounting should not be confused with adjusting for inflation. Both are needed. The inflation adjustment reflects the change in purchasing power of currency. Discounting reflects the loss in value when there is a delay in obtaining an item of value. We discount expenses and health outcomes if there is a delay in realizing them.
References
Berndt ER, DM Cutler, RG Frank. JP Newhouse, JE Triplett. Medical care prices and output. In Handbook of Health Economics, Volume 1, AJ Culyer and JP Newhouse, eds. San Francisco: Elsevier, 2000.
Lipscomb J, Weinstein MC, Torrance GW. Time preference. In Cost-Effectiveness in Health and Medicine, M Gold, J Siegel, LB Russell, and MC Weinstein, eds. New York: Oxford, 1996.