The Equation Building a Better Measure of Inflation

Measuring inflation isn’t straightforward, especially the way economists typically do it, by constructing a price index. Products evolve, improve, and are retired, while new products can be omitted or categorized differently. All of this can distort an index.  

But some products are reasonably immune to these measurement issues, according to research by Yale’s David Argente, Chicago Booth’s Chang-Tai Hsieh, and University of California at San Diego’s Munseob Lee. The researchers identified a set of such “chosen products,” whose prices are measured more reliably, and used them to estimate overall inflation.

Their method relies on the idea that when spending moves toward or away from chosen products, those shifts can indicate how prices are changing elsewhere in the economy. This works because consumers substitute among products and respond to relative prices. By combining spending shifts with the chosen products’ own price changes, economists can infer the average price level across all goods and services in the economy. To learn more, read “Is Inflation Being Understated?”