How Much Do Medicare Cuts Reduce Inflation?

We assess the impact of Medicare's administratively set payment rates on inflation in the health care sector and the overall economy.  Because the health sector makes up a large share of the U.S. economy, widespread price changes for medical services can significantly impact overall inflation.  Medicare’s influence is especially prominent since public sector health care prices spill over into the private sector.  We first compute the full effect of the Medicare payment cuts from the 2011 Budget Control Act on overall economy-wide inflation.  We find that these cuts, part of the broader federal “budget sequester,” resulted in a decline of 0.24 percentage point in the overall national price level. This is over twice the expected drop if private-sector spillovers are not included.  We next investigate the contribution of Medicare payment policies to the low inflation levels that persist today, despite the ongoing economic recovery.  This low inflation reflects a decline in inflation for services, which has been driven by a steady fall in health care services inflation over the last decade and especially the past two years. Much of this recent fall results from Medicare payment reductions.  Looking ahead, Medicare payment policies call for growth rates to remain very low.  The private sector spillovers imply that overall health care services inflation will likely follow suit.