Indexing Inflation: The Impact of Methodology on Econometrics and Macroeconomic Policy

Central Bank Journal of Law and Finance, Vol. 1, pp. 3-47, 2014

45 Pages Posted: 2 Aug 2014 Last revised: 8 Oct 2015

James Ming Chen

Michigan State University - College of Law

Date Written: July 31, 2014

Abstract

Because there is no perfect gauge of inflation, the macroeconomic enterprise of indexing inflation ultimately dissolves into a choice among imperfect methodologies. But that choice still matters. This article will highlight the practical significance of methodological choices made in the course of indexing inflation. It will focus on two different indexes of inflation in the United States: the Consumer Price Index (CPI) and the implicit price deflator of the gross domestic product (IPD). This article identifies a long-term gap in these competing indexes’ measurement of inflation. To explain why the CPI appears to overstate inflation, relative to the IPD, by roughly two-thirds of a percentage point each year, this article more fully describes the distinct methodologies underlying the CPI and the IPD. Lawmakers should adopt the implicit price deflator of the GDP, or some other inflation index that shares its best methodological features, as the best practicable measure of real growth and price change in the national economy.

Keywords: inflation, consumer price index, implicit price deflator, gross domestic product, CPI, GDP, macroeconomics

JEL Classification: E01, E31

Suggested Citation

Chen, James Ming, Indexing Inflation: The Impact of Methodology on Econometrics and Macroeconomic Policy (July 31, 2014). Central Bank Journal of Law and Finance, Vol. 1, pp. 3-47, 2014. Available at SSRN: https://ssrn.com/abstract=2474949

James Ming Chen (Contact Author)

Michigan State University - College of Law ( email )

318 Law College Building
East Lansing, MI 48824-1300
United States

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