Inflation

Measurement

Warning

There’s no such thing as THE inflation indicator!

• GDP Deflator inflation
• CPI, more volatile than GDP-deflator inflation, more affected by volatile oil prices
• PPI, similar to CPI.
• The change in the personal consumption expenditure deflator, which is the actual indicator used by Fed.

Biases

• Substitution bias: relative price changes over time, consumers switch to substitutions. Somewhat corrected through chain-weighting in GDP deflator calculation, but not in CPI.
• Outlet bias: price of same product maybe lower in other channels.
• Quality bias: consumers can switch to products with lower quality
• New goods bias: new goods may not be included in the basket, e.g. new iPhone

It is estimated that all these biases add up to an overestimation of inflation of up to 2%.

Resources

• Coffee, consumer choice, and the consequences of Columbus.
• Do We Need Google To Measure Inflation?
• A San Francisco Fed memo on the four inflation biases