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Alternative Strategies for Aggregating Prices in the CPI

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  • Matthew D. Shapiro
  • David W. Wilcox

Abstract

The Consumer Price Index does not take into account the fact that consumers alter the composition of their purchases in response to changes in relative prices. This substitution effect will cause the CPI to grow faster than the cost of living. This paper presents new estimates showing that this bias in the CPI averaged 0.3 percentage points per year between December 1986 and December 1995. This bias could be eliminated by using a superlative index to aggregate prices across the item-area strata of the CPI. The paper discusses the practical difficulties in implementing such a calculation and suggests a method for overcoming them. In particular, it shows how to construct an accurate approximation to a superlative price index that can be published with the same timeliness as the CPI.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5980.

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Date of creation: Mar 1997
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Publication status: published as Federal Reserve Bank of St. Louis Review, vol 79, no. 3, pp. 113-125, May/June 1997
Handle: RePEc:nbr:nberwo:5980

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  1. Diewert, W. E., 1976. "Exact and superlative index numbers," Journal of Econometrics, Elsevier, Elsevier, vol. 4(2), pages 115-145, May.
  2. Braithwait, Steven D, 1980. "The Substitution Bias of the Laspeyres Price Index: An Analysis Using Estimated Cost-of-Living Indexes," American Economic Review, American Economic Association, American Economic Association, vol. 70(1), pages 64-77, March.
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Cited by:
  1. Charles Steindel, 1997. "Are there good alternatives to the CPI?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 3(Apr).
  2. Christos Ioannidis & Mick Silver, 2003. "Chained, exact and superlative hedonic price changes: estimates from microdata," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 35(9), pages 1005-1014.
  3. David E. Lebow & Jeremy B. Rudd, 2006. "Inflation measurement," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2006-43, Board of Governors of the Federal Reserve System (U.S.).
  4. Gregor W. Smith, 2009. "The Missing Links: Better Measures of Inflation and Inflation Expectations in Canada," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 287, April.
  5. Robert J. Gordon, 2006. "The Boskin Commission Report: A Retrospective One Decade Later," International Productivity Monitor, Centre for the Study of Living Standards, Centre for the Study of Living Standards, vol. 12, pages 7-22, Spring.
  6. Jan Hanousek & Randall K. Filer, 2001. "Evaluating Imperfections and Biases in Price Indexes during Transition," CERGE-EI Working Papers wp186, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  7. Robert J. Gordon, 2000. "The Boskin Commission Report and its Aftermath," NBER Working Papers 7759, National Bureau of Economic Research, Inc.
  8. Jan Hanousek & Randall K. Filer, 2003. "Substitution Biases in Price Indexes during Transition," Development and Comp Systems 0306002, EconWPA.
  9. Jerry Hausman, 2002. "Sources of Bias and Solutions to Bias in the CPI," NBER Working Papers 9298, National Bureau of Economic Research, Inc.
  10. R. A. Somerville, 2004. "Changes in Relative Consumer Prices and the Substitution Bias of the Laspeyres Price Index - Ireland, 1985-2001," The Economic and Social Review, Economic and Social Studies, Economic and Social Studies, vol. 35(1), pages 55-82.
  11. Lieu, Pang-Tien & Liang, Jung-Hui & Chen, Jui-Hui, 2008. "Consumer preferences and cost of living in Taiwan," Journal of Asian Economics, Elsevier, Elsevier, vol. 19(3), pages 224-235, June.
  12. Courtney, Mark, 2013. "Consumer price indices and the identification problem," MPRA Paper 54137, University Library of Munich, Germany.
  13. John S. Greenlees & Elliot Williams, 2009. "Reconsideration of Weighting and Updating Procedures in the US CPI," Working Papers, U.S. Bureau of Labor Statistics 431, U.S. Bureau of Labor Statistics.
  14. Petter Frenger, 2006. "The substitution bias of the consumer price index," Discussion Papers, Research Department of Statistics Norway 451, Research Department of Statistics Norway.
  15. Baclajanschi, Iaroslav & Bouton, Lawrence & Mori, Hideki & Ostojic, Dejan & Pushak, Taras & Tiongson, Erwin R., 2006. "The impact of energy price changes in Moldova," Policy Research Working Paper Series 3960, The World Bank.

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