Mismeasurement in the Consumer Price Index: An Evaluation

73 Pages Posted: 16 Sep 1996 Last revised: 13 May 2000

See all articles by Matthew D. Shapiro

Matthew D. Shapiro

University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

David W. Wilcox

Federal Reserve Board - Division of Research and Statistics

Multiple version iconThere are 2 versions of this paper

Date Written: May 1996

Abstract

A number of analysts have claimed recently that the consumer price index overstates the annual increase in the cost of living. This paper develops a framework for studying measurement problems in the consumer price index and systematically analyzes the available evidence concerning the magnitude of these problems. It concludes that the CPI overstates increases in the cost of living. The evidence suggests that the bias is centered on 1.0 percentage point per year. The extent of this bias is not known exactly. To take into account this uncertainty, the estimated bias is presented in terms of a probability distribution rather than a point estimate or range. We estimate that there is a 10 percent chance that the bias is less than 0.6 percentage point and a 10 percent chance that it is greater than 1.5 percentage points per year. CPI procedures overstate the rate of inflation for medical procedures that are subject to technological improvement. To illustrate this point and to show how better to measure medical care prices, the paper presents a prototypical price index for cataract surgery. This price index grows much more slowly than a price index for cataract surgery constructed using the methodology of the CPI. The paper discusses implications of CPI mismeasurement for monetary and fiscal policy as well as for other official statistics. It also offers some suggestions for improving the CPI.

Suggested Citation

Shapiro, Matthew D. and Wilcox, David W., Mismeasurement in the Consumer Price Index: An Evaluation (May 1996). NBER Working Paper No. w5590. Available at SSRN: https://ssrn.com/abstract=3316

Matthew D. Shapiro (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

and Survey Research Center
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National Bureau of Economic Research (NBER) ( email )

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David W. Wilcox

Federal Reserve Board - Division of Research and Statistics ( email )

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Washington, DC 20551
United States

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