A half-year pause in inflation: its antecedents and structure - Consumer price index suggests lowest inflation rate in 20 years

Monthly Labor Review, Oct, 1986 by John F. Early, Walter Lane, Philip Sturm

Despite these factors, however, charges for services by medical professionals have stubbornly grown at annual rates in excess of 6 percent. One factor which may have contributed to this continued inflation is the widely publicized substantial increases in malpractice insurance premiums. These increases have tapered off, but continue to be quite high. After jumping more than 40 percent in 1982, average premium increases by 1984 were down to a smaller but still substantial 18.3 percent.10 It is also possible that the measured CPI increases reflect more than pure price change. New diagnostic and treatment methods, procedures, and equipment may increase the costs of professional services. At the same time, however, they may improve the efficiency and efficacy of a diagnosis or treatment. To the extent that the higher charges are the result of better medical care, the increases are not pure price increases and should, in principle, not be included in the CPI. We do not know whether such quality increases are in fact contributing to the continued substantial rises in the medical care CPI, but it is a possibility that must be kept in mind.

Charges for hospital rooms and for other hospital and medical care services both rose at very high double-digit rates through 1982. Like many large service organizations, hospitals tend to be slow to adjust their fee schedules to reflect changes in their costs. As a result, slower price increases for hospitals came later than for many other segments of the economy--including those by medical professionals. Nevertheless, from 1983 through 1985, hospital fees slowed down quited significantly. Like the professional services component of the CPI, hospital costs have benefited from modest rises in compensation costs for employees. In addition, hospitals have come under increasing regulatory scrutiny by Federal, State and local government units in an effort to contain cost increases. In October 1983, the Federal Government imposed a Diagnostic Related Groups (DRG) fee structure on hospitals being reimbursed for Medicare-financed treatment. Under this process, a set fee is established for a specific class of treatment irrespective of the duration or specific procedures followed in a particular case. The objective is to encourage providers to identify and use the most cost-effective treatment. Some insurance carriers and health maintenance organizations (HMO's) are also establishing similar payment regimens.

Some of the slowing in hospital charges may reflect market adjustments to oversupply of hospital capacity. Between 1978 and 1984, occupancy rates in hospitals declined from 75.5 percent to 72.5,11 at least partly as the result of shorter hospital stays. The average length of a hospital stay declined from 7.4 days in 1978 to 6.6 days in 1984.(12)

Following their substantial slowdown through 1985, hospital fees began to accelerate again during the first half of 1986. This rather abrupt turnaround is difficult to explain. The possible effects of liability insurance and higher quality care are, of course, factors for hospitals as well as professional services, but there is no obvious reason these effects should have become more pronounced in the first 6 months of 1986.