How Much Do Official Price Indexes Tell Us About Inflation?

49 Pages Posted: 5 Oct 2013 Last revised: 17 Oct 2022

See all articles by Jessie Handbury

Jessie Handbury

University of Pennsylvania, The Wharton School

David E. Weinstein

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

Tsutomu Watanabe

Hitotsubashi University - Institute of Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: October 2013

Abstract

Official price indexes, such as the CPI, are imperfect indicators of inflation calculated using ad hoc price formulae different from the theoretically well-founded inflation indexes favored by economists. This paper provides the first estimate of how accurately the CPI informs us about "true" inflation. We use the largest price and quantity dataset ever employed in economics to build a Törnqvist inflation index for Japan between 1989 and 2010. Our comparison of this true inflation index with the CPI indicates that the CPI bias is not constant but depends on the level of inflation. We show the informativeness of the CPI rises with inflation. When measured inflation is low (less than 2.4% per year) the CPI is a poor predictor of true inflation even over 12-month periods. Outside this range, the CPI is a much better measure of inflation. We find that the U.S. PCE Deflator methodology is superior to the Japanese CPI methodology but still exhibits substantial measurement error and biases rendering it a problematic predictor of inflation in low inflation regimes as well.

Suggested Citation

Handbury, Jessie and Weinstein, David E. and Watanabe, Tsutomu, How Much Do Official Price Indexes Tell Us About Inflation? (October 2013). NBER Working Paper No. w19504, Available at SSRN: https://ssrn.com/abstract=2336369

Jessie Handbury

University of Pennsylvania, The Wharton School ( email )

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David E. Weinstein

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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Tsutomu Watanabe

Hitotsubashi University - Institute of Economic Research ( email )

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Japan

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