Is Inflation Being Understated?

For economists, measuring inflation in the real world is a lot tougher than it might seem at first blush. Sure, reporting the cost of a standard gadget requires little more than tracking its price from one year to the next. But in modern markets, products are constantly changing.

Your cell phone is a prime example. You might have paid roughly the same amount for your latest model as the one you bought a decade ago. But given the difference in features, and how many different kinds of phones are now available, is the comparison really equivalent? Economists typically measure inflation for such evolving products by adjusting for the quality and variety of goods offered.

This method is dauntingly complex and has understated inflation by up to 1 percent, suggests research by Yale’s David Argente, Chicago Booth’s Chang-Tai Hsieh, and University of California at San Diego’s Munseob Lee. They have devised a different way of monitoring inflation that incorporates information about consumer demand for goods rather than only using information about prices.

To track inflation, many economists use the Bureau of Labor Statistics’ Consumer Price Index, which measures the average prices paid by consumers for a representative basket of goods and services. But this leads to two common miscalculations, the researchers write. The first involves inaccuracies in the measurement of the ever-changing quality and variety of products. The second relates to the categorization of new products such as the iPad, which could as easily be dubbed a television as a computer or cell phone. For its part, the Bureau of Economic Analysis’s Personal Consumption Expenditures Price Index (PCEPI)—which measures changes in a broader range of goods and services and is also used to assess inflation—does attempt to adjust for quality changes, but bias remains.

The researchers wondered if they could avoid these miscalculations by using information gleaned from spending data. They considered the evolution of the dairy aisle, where Greek yogurt has taken up more shelf space in recent years. Over the decade between 2007 and 2017, the quality of Greek yogurt rose dramatically as suppliers increased the protein content, added probiotics, reduced sugar, and improved the texture. These improvements did not move prices much but had a dramatic effect on consumer spending. At the outset, regular yogurt varieties accounted for virtually all purchases. Ten years later, buyers were allocating half their dollars to Greek yogurt.

“The key idea is that if you have an accurate measure of the price of one good, you can use changes in the market share to measure the effective price of all the other goods,” says Hsieh.

But, “the empirical challenge is to identify a set of products for which measured prices are reasonably immune to the measurement issues that plague many products,” the researchers write.