Measurement Errors and Quality-Adjustment Methodology: Lessons from the Japanese CPI (Economic Perspectives Vol. 23, No. 2, Federal Reserve Bank of Chicago, 2nd Quarter 1999) PDF File / Japanese Version
This article examines the problems inherent to the quality changes/new goods bias in the consumer price index (CPI), using the Japanese case as an example. The CPI is widely used as a measure of inflation. However, there is a growing consensus that the CPI substantially overstates changes in the true cost of living. Upward bias in the CPI arises because the current CPI fails to account for the dynamic nature of economic activity, such as changes in consumers’ behavior in response to relative price fluctuations between goods, the introduction of new goods, and the disappearance of old goods. Upward bias in the CPI has a direct implication for monetary policymakers, whose major mandate is to maintain price stability. Moreover, accurate price measures are necessary to interpret economic developments, not only involving inflation but also real output and productivity. Keeping these discussion in mind, in this article, I review the sources of measurement errors in the CPI and examine the problems inherent in the methodology used for quality adjustment in the Japanese CPI. Then I describe the basic framework of the hedonic approach (methodology to analyze the price?quality relationship by regressing prices on numerous characteristics of a product) and propose a practical way to improve the accuracy of quality adjustment by introducing this approach to the conventional procedure to compile the CPI.