The Controversy over the Consumer Price Index

Not everyone feels that the Boskin Commission has made its case. Why the differences? Some of the critical points have been made by Professor Alan Krueger. The most important ones seem to be

The Commission overcounted quality improvement.: He writes, "A major concern with research on the CPI is that it has focused almost exclusively on biases that go in one particular direction -- toward overstatement."
The Commission didn't count the "other issues" not included in GDP.: In Krueger's words, "And research on the CPI ignores non-market goods, such as the quality of public services (e.g., schools) and the environment. A true cost of living index would take these factors into account."

In addition, the Commission study looks to the past. To what extent can we expect the biases to continue to exaggerate inflation in the future? The commission's own report raises the issue. Writing about one particular problem with the Consumer Price Index, they note "The bias for 1975 ... was 1.1 percent. This bias mounted over subsequent years, reaching 6.5 percent by 1982 and then declining to 4.7 percent in 1984. " On this particular score, the CPI was actually closer in 1984 than it had been in 1982. So the CPI overstated inflation during one period, but understated it in another -- if there were no other sources of bias. So we might want to be careful in using the bias in the Consumer Price Index in making decisions about future economic policy.

The answer on this issue will depend on the source of bias. For example

Most economists would agree that "substitution bias" is here to stay. It can only be eliminated by replacing the Consumer Price Index by another kind of index, a "chain" index.
As to the "outlet substitution bias," the shift to superstores will eventually stop -- even if it doesn't stop until the superstore market share is 100%.

And if the Consumer Price Index is so bad, why have we used it for 60 years? The Boskin Commission itself gives part of the answer: it is simple and relatively easy to interpret: "The strength of the CPI is in the underlying simplicity of its concept: pricing a fixed (but representative) market basket of goods and services over time. " (We have already seen that the alternatives, such as the 'chain" index, are not as simple and are harder to interpret.) It is also relatively cheap to produce, since the market survey used for the fixed market basket of goods and services needs only be done once every 10 years or so.

What conclusions can we draw from all this controversy?

Balancing the Arguments