Price Index Numbers Under Large-Scale Demand Shocks: The Japanese Experience of the COVID-19 Pandemic

This study examines the effects of the coronavirus disease 2019 (COVID-19) pandemic on consumer price indices using Japanese face mask scanner data. We show that the COVID-19 pandemic causes a shift in consumers’ preferences to a large extent, and the Paasche index becomes greater than the Laspeyres index. When large-scale changes in preferences occur, the standard superlative index, such as the Fisher or Tornqvist indices, are hard to be regarded as the cost of living index (COLI) defined based on consumer theory. Using a recently developed index number formula that is exact for the constant elasticity of the substitution utility function with variable preferences, we quantify the degree of the demand shock caused by the COVID-19 pandemic. We also show that shifts in preferences are so large that by incorporating the changes in preferences, the COLI becomes very different from the standard superlative indices. While the prices of face masks became lower in the Fisher index in May 2020 by 0.76% per week, the COLI increased by 1.92% per week. The magnitude of the bias caused by the demand shock is so substantial that traditional index numbers might carry the wrong information on the cost of living among consumers.