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The Consumer Price Index as a Measure of Inflation

  • Michael F. Bryan
  • Stephen G. Cecchetti

As inflation approaches zero, it becomes increasingly important to examine the price indices on which monetary policy is based. The most popularly used aggregate price statistic in the U.S. is the Consumer Price Index (CPI), a statistic that appears to be a focal point in monetary policy deliberations. A problem associated with using the CPI, a fixed weight index of the cost-of-living, is that there are likely to be biases in the index as a measure of inflation. In this paper we use a simple statistical framework to compute a price index that is immune to one of the potentially important biases inherent in the CPI as a measure of inflation--weighting bias. Utilizing a dynamic factor model we are able to compute the common inflation element in a broad cross-section of consumer price changes. Our conclusion is that, although there was a large positive weighting bias during the fifteen years beginning in 1967, since 1981 the weighting bias in the CPI as a measure of inflation has been insignificant.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4505.

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Date of creation: Oct 1993
Date of revision:
Publication status: published as Economic Review of the Federal Reserve, Bank of Cleveland, vol. 29, no. 4 1993, Quarter 4, p. 15-24
Handle: RePEc:nbr:nberwo:4505
Note: ME
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  1. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 5(1), pages 173-91, Part I Fe.
  2. Robert J. Gordon, 1992. "Measuring the Aggregate Price Level: Implications For Economic Performance and Policy," NBER Working Papers 3969, National Bureau of Economic Research, Inc.
  3. Ball, L. & Mankiw, G.H., 1992. "Relative-Price Change as Aggregate Supply Shocks," Harvard Institute of Economic Research Working Papers 1609, Harvard - Institute of Economic Research.
  4. Michael F. Bryan & Stephen G. Cecchetti, 1993. "Measuring Core Inflation," NBER Working Papers 4303, National Bureau of Economic Research, Inc.
  5. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  6. 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, vol. 70(1), pages 64-77, March.
  7. Mark A. Wynne & Fiona Sigalla, 1993. "A survey of measurement biases in price indexes," Research Paper 9340, Federal Reserve Bank of Dallas.
  8. James H. Stock & Mark W. Watson, 1988. "A Probability Model of The Coincident Economic Indicators," NBER Working Papers 2772, National Bureau of Economic Research, Inc.
  9. David E. Lebow & John M. Roberts & David J. Stockton, 1992. "Economic performance under price stability," Working Paper Series / Economic Activity Section 125, Board of Governors of the Federal Reserve System (U.S.).
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