Abstract
This paper addresses the definition and measurement objective of the U.S. Consumer Price Index (CPI), together with the Bureau of Labor Statistics (BLS) response to the estimates of bias put forward in the final report of the Advisory Commission to Study the Consumer Price Index and to the specific recommendations made to the Bureau by the commission. The advisory commission compared the CPI to a hypothetical ideal measure of the change in the cost of living and concludes that in several respects the CPI is biased relative to this standard. The categories of bias discussed by the commission include: substitution bias, outlet bias, quality change bias, and new product bias. The commission, using empirical evidence and the members' own judgments about the magnitude of these biases, concluded that the CPI overstates the true cost-of-living change by 1.1 percentage points per year.
Based on this, the commission recommended that the BLS make several changes in the methods used in constructing the CPI, including more frequent updates of the market basket and expenditure information required by the index and the use of formulas more consistent with the theoretical cost-of-living concept. They recommended explicitly adopting the cost-of-living index as the measurement objective of the CPI, replacing the current index by two indexes – a monthly index that takes account of the changing market basket and a second annual index calculated using a “superlative” formula and subject to revision – and using geometric means for aggregating elementary price quotes.
The objectives of the present paper are: first, to discuss the relationship of the CPI to the conceptual cost-of-living index; second, to review and critique the advisory commission's estimates of bias; and third, to respond to the detailed recommendations made by the commission.
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