Abstract
The accurate measure of prices is fundamental to almost every important issue in economics, from measuring economic progress to the conduct of monetary policy to the indexation of private contracts and public programs and tax rules. This paper reviews the causes of bias in the United States Consumer Price Index (CPI), updates the estimate of such bias (now roughly 0.8 percent per annum) following several improvements by the Bureau of Labor Statistics (BLS), notes the likely far larger substitution bias than previously estimated and calls for a series of priority improvements. Particular attention is called to the over 40 basis point slower growth of the BLS’ C-CPI-U compared to the CPI-U, more than double the early 1990s estimates, which highlights the importance of moving to a formula such as the chained Tornqvist C-CPI that corrects for traditional substitution bias. The implications for mismeasuring the growth of real wages, real median income, and real returns to stocks and bonds are developed, as are the budgetary implications of the overindexing of spending and tax brackets resulting from the overstatement of changes in the cost of living.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Bajari, Patrick; Benkard, Lanier C.; Krainer, John. “House Prices and Consumer Welfare,” Unpublished mimeo, Stanford University, 2002.
Boskin, M.; Jorgenson, D. “Implications of Overstating Inflation for Indexing Government Programs and Understanding Economic Progress,” American Economic Review, 87, May 1997, pp. 78–83.
Boskin, M.; Dulberger, E.; Gordon, R.; Griliches, Z.; Jorgenson, D. “Toward a More Accurate Measure of the Cost of Living,” Report of the Advisory Commission on the Consumer Price Index. Washington, DC, United States Senate, December, 1996.
Boskin, M.; Dulberger, R.; Gordon, Griliches Z.; Jorgenson, D. “The CPI Commission: Findings and Recommendations,” American Economic Review, 87, May 1997, pp. 89–93.
Boskin, M.; Dulberger, E.; Gordon, R.; Griliches, Z.; Jorgenson, D. “Consumer Prices, The Consumer Price Index and the Cost of Living,” Journal of Economic Perspectives, 1998.
Diewert, E. “Exact and Superlative Index Numbers,” Journal of Econometrics, 4, 2, May 1976, pp. 115–45.
Fisher, I. The Making of Index Numbers: A Study of Their Varieties, Tests, and Reliability, Boston and New York: Houghton, Mifflin Co., 1922.
Gordon, Robert J., “A Century of Housing Shelter Prices: How Big Is the CPI Bias?,” Conference on Research in Income and Wealth, Mimeo, 2003.
Hausman, J. A. “Valuation of New Goods Under Perfect and Imperfect Competition,” in The Economics of New Goods, T. F. Bresnahan, and R. J. Gordon, (eds.), Chicago: University of Chicago Press, 1997, p. 209.
Hausman, J. “CPI Bias from Supercenters: Does the BLS Know that Wal-Mart Exists?,” Cambridge, MA: National Bureau of Economic Research, NBER Working Paper 10712, 2004.
Hicks, J. “The Valuation of the Social Income,” Economica, 7, May 1940, pp. 105–124.
Ibbotson Associates. Stocks, Bonds, Bills and Inflation—2002 Yearbook. Chicago, IL: Ibbotson Associates, 2002.
Lebow, D.; Rudd, J. “Measurement Error in the Consumer Price Index: Where Do We Stand?,” Journal of Economic Literature, March 2003.
National Academy of Sciences. “At What Price?: Conceptualizing and Measuring Cost-of-Living and Price Indexes,” in Panel on Conceptual, Measurement, and Other Statistical Issues in Developing Cost-of-Living Indexes, Charles Schultze, and Christopher Mackie, (eds.), Committee on National Statistics, National Research Council, 2002.
Shapiro, M.; Wilcox, D. “Alternative Strategies for Aggregating Prices in the CPI,” Federal Reserve Bank of St. Louis Review, 79, May/June 1997, pp. 113–25.
Shoven, J. What Are Reasonable Long-Run Rates of Return to Expect in Equities?, Washington, DC: Social Security Advisory Board, August 2001.
Siegel, J. Stocks for the Long Run, 2nd ed., New York: McGraw-Hill, 2002.
Stewart, K.; Reed, S. “Consumer Price Index Research Series Using Current Methods, 1978–1998,” Monthly Labor Review, June 1999. (An update is available on the BLS website.)