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A cost-of-living dynamic price index, with an application to indexing retirement accounts

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  • Reis, Ricardo

Abstract

If a consumer wishes to protect her retirement account from the risk of price changes in order to sustain a stable standard of living, then what price index should the account be indexed to? This paper constructs a dynamic price index (DPI) that answers this question. Unlike the existing theory on price indices (which is static and certain), the DPI measures the cost of living for a consumer who lives for many periods and faces uncertainty. The first contribution of this research is to define this price index and study its theoretical properties. The DPI: is homogeneous of degree 1 with respect to all prices, is forward-looking with respect to price shocks, responds more to permanent vis-à-vis transitory price changes, includes asset prices with a potentially large weight, and distinguishes between durable and non-durable goods prices. The second contribution of the paper is to construct a DPI for the United States from 1970 to 2004. It gives an account of the cost of living in the U.S. that is strikingly different from the one provided by the CPI. The DPI is less persistent, more volatile, and a large part of its movements are driven by changes in the prices of houses and bonds.

Suggested Citation

  • Reis, Ricardo, 2005. "A cost-of-living dynamic price index, with an application to indexing retirement accounts," CEPR Discussion Papers 5394, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:5394
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    Cited by:

    1. Oleksiy Kryvtsov, 2016. "Is there a quality bias in the Canadian CPI? Evidence from microdata," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 49(4), pages 1401-1424, November.
    2. Mark W. Watson & Ricardo Reis, 2007. "Measuring changes in the value of the numeraire," 2007 Meeting Papers 324, Society for Economic Dynamics.
    3. Thorsten V. Koeppl, 2009. "How Flexible Can Inflation Targeting Be? Suggestions for the Future of Canada's Targeting Regime," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 293, August.
    4. Aoki, Shuhei & Kitahara, Minoru, 2008. "Measuring the Dynamic Cost of Living Index from Consumption Data," MPRA Paper 9802, University Library of Munich, Germany.
    5. Shuhei Aoki & Minoru Kitahara, 2010. "Measuring a Dynamic Price Index Using Consumption Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(5), pages 959-964, August.
    6. Tödter Karl-Heinz & Ziebarth Gerhard, 2021. "Lifetime Cost of Living and Effective Prices: Theory and Evidence for Germany," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 241(1), pages 29-69, February.

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    More about this item

    Keywords

    Consumer price index; Cost-of-living index; inflation; retirement accounts;
    All these keywords.

    JEL classification:

    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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