Policy, especially monetary policy, is about numbers. Is inflation close to target? How fast is the economy growing? What fraction of the workforce is employed? And, what is the relationship between the policymakers’ tools and their objectives? Answering all of these questions requires measuring a broad array of economic indicators, with consumer prices high on the list. In this post, we discuss some of the pitfalls in measuring prices.
Price indices of the sort that we use today have been around since the late 19th century. In the United States, near the end of World War I, the National Industrial Conference Board starting constructing and publishing a cost-of-living index. This work was eventually taken over by the Bureau of Labor Statistics (BLS). Over the past century, the theory of price indexes (see, for example, here and here) and the means of measurement have both moved forward substantially.
With the advent of inflation targeting, price indices have taken on a new prominence. If monetary policymakers are going to focus on controlling inflation—setting numerical targets for which they are then held accountable—then the construction of the price index itself becomes an issue. What is included and how can become critical to the way policy is conducted and to the achievement of the stated objective, namely price stability....Read More