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Measurement error in the consumer price index: where do we stand?

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  • David E. Lebow
  • Jeremy B. Rudd
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    Abstract

    We survey the evidence bearing on measurement error in the CPI and provide our best estimate of the magnitude of CPI bias. We also identify a "weighting" bias in the CPI that has not been previously discussed in the literature. In total, we estimate that the CPI overstates the change in the cost of living by about 0.6 percentage point per year, with a confidence interval that ranges from 0.1 to 1.2 percentage points. Roughly half of this bias is accounted for by the CPI's inability to fully capture the welfare improvement from quality change and the introduction of new items. Our bias estimate is smaller than that found in several earlier studies, in part because the BLS has recently made a variety of improvements to its procedures; our study highlights several potential areas for further improvement.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-61.

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    Date of creation: 2001
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    Handle: RePEc:fip:fedgfe:2001-61

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    Keywords: Consumer price indexes;

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    References

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    1. Robert C. Feenstra & Matthew D. Shapiro, 2001. "High-Frequency Substitution and the Measurement of Price Indexes," NBER Working Papers 8176, National Bureau of Economic Research, Inc.
    2. David M. Cutler & Mark B. McClellan & Joseph P. Newhouse & Dahlia K. Remler, 2001. "Pricing Heart Attack Treatments," NBER Chapters, in: Medical Care Output and Productivity, pages 305-362 National Bureau of Economic Research, Inc.
    3. Ernst R. Berndt & David M. Cutler & Richard G. Frank & Zvi Griliches & Joseph P. Newhouse & Jack E. Triplett, 1998. "Price Indexes for Medical Care Goods and Services: An Overview of Measurement Issues," Harvard Institute of Economic Research Working Papers 1851, Harvard - Institute of Economic Research.
    4. Blow, Laura & Crawford, Ian, 2001. "The Cost of Living with the RPI: Substitution Bias in the UK Retail Prices Index," Economic Journal, Royal Economic Society, vol. 111(472), pages F357-82, June.
    5. Angus Deaton, 1998. "Getting Prices Right: What Should Be Done?," Journal of Economic Perspectives, American Economic Association, vol. 12(1), pages 37-46, Winter.
    6. Ernst R. Berndt & Susan Busch & Richard Frank, 2001. "Treatment Price Indexes for Acute Phase Major Depression," NBER Chapters, in: Medical Care Output and Productivity, pages 463-508 National Bureau of Economic Research, Inc.
    7. Zvi Griliches & Iain Cockburn, 1993. "Generics and New Goods in Pharmaceutical Price Indexes," NBER Working Papers 4272, National Bureau of Economic Research, Inc.
    8. Hausman, Jerry, 1999. "Cellular Telephone, New Products, and the CPI," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(2), pages 188-94, April.
    9. Gordon, Robert J., 1990. "The Measurement of Durable Goods Prices," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226304557.
    10. Iain M. Cockburn & Aslam H. Anis, 1998. "Hedonic Analysis of Arthritis Drugs," NBER Working Papers 6574, National Bureau of Economic Research, Inc.
    11. Deaton,Angus & Muellbauer,John, 1980. "Economics and Consumer Behavior," Cambridge Books, Cambridge University Press, number 9780521296762, October.
    12. Theodore M. Crone & Leonard I. Nakamura & Richard Voith, 1999. "Measuring housing services inflation," Working Papers 99-9, Federal Reserve Bank of Philadelphia.
    13. David H. Good & Robin C. Sickles & Jesse C. Weiher, 2008. "A Hedonic Price Index For Airline Travel," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 54(3), pages 438-465, 09.
    14. Mark Bils & Peter J. Klenow, 2000. "Quantifying Quality Growth," NBER Working Papers 7695, National Bureau of Economic Research, Inc.
    15. Robert J. Gordon, 2000. "The Boskin Commission Report and its Aftermath," NBER Working Papers 7759, National Bureau of Economic Research, Inc.
    16. Bruce W. Hamilton, 2001. "Using Engel's Law to Estimate CPI Bias," American Economic Review, American Economic Association, vol. 91(3), pages 619-630, June.
    17. Deaton, Angus S & Muellbauer, John, 1980. "An Almost Ideal Demand System," American Economic Review, American Economic Association, vol. 70(3), pages 312-26, June.
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    Cited by:
    1. Jason G. Cummins & Giovanni L. Violante, 2002. "Investment-specific technical change in the US (1947-2000): measurement and macroeconomics consequences," Finance and Economics Discussion Series 2002-10, Board of Governors of the Federal Reserve System (U.S.).
    2. Berka, Martin, 2006. "Non-linear adjustment in law of one price deviations and physical characteristics of goods," MPRA Paper 8606, University Library of Munich, Germany, revised Dec 2007.
    3. Bart Hobijn, 2002. "On both sides of the quality bias in price indexes," Staff Reports 157, Federal Reserve Bank of New York.
    4. Daniel Leigh, 2004. "Monetary Policy and the Dangers of Deflation:Lessons from Japan," Economics Working Paper Archive 511, The Johns Hopkins University,Department of Economics.
    5. Roy H. Webb, 2004. "Which price index should a central bank employ?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 63-76.
    6. Peter J. Klenow, 2003. "Measuring consumption growth: the impact of new and better products," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 10-23.

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