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The Consumer Price Index as a Measure of Inflation

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  • Michael F. Bryan
  • Stephen G. Cecchetti

Abstract

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.

Suggested Citation

  • Michael F. Bryan & Stephen G. Cecchetti, 1993. "The Consumer Price Index as a Measure of Inflation," NBER Working Papers 4505, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:4505
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    References listed on IDEAS

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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 173-191, Part I Fe.
    2. Wynne, Mark A & Sigalla, Fiona D, 1996. " A Survey of Measurement Biases in Price Indexes," Journal of Economic Surveys, Wiley Blackwell, vol. 10(1), pages 55-89, March.
    3. Michael F. Bryan & Stephen G. Cecchetti, 1994. "Measuring Core Inflation," NBER Chapters,in: Monetary Policy, pages 195-219 National Bureau of Economic Research, Inc.
    4. Laurence Ball & N. Gregory Mankiw, 1995. "Relative-Price Changes as Aggregate Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 161-193.
    5. 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.
    6. Gordon, Robert J, 1992. "Measuring the Aggregate Price Level: Implications for Economic Performance and Policy," CEPR Discussion Papers 663, C.E.P.R. Discussion Papers.
    7. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    8. 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.).
    9. 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.
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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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