How do you turn a 400% price increase into a 7.1% decline?

We have long believed that quality adjustments to the consumer price index were kind of weird, or at least not intuitive.

Basically the BLS uses a process called Hedonic Regression whereby it takes the “quality” of an item into account when its price increases.

This blog post summarizes how it can be used to turn a 400% price increase into a decline purely because the quality increased. Makes you think twice given 32% of the items in the CPI are subject to quality adjustments…

The Consumer Price Illusion

Have you heard the one about CPI?

Suppose that a TV manufacturer retires a product and replaces it with a newer, better, and much more expensive one. If the new TV costs 5 times more than the old one, how can we gently massage the price of the old TV to make it look like the price fell? By using the dark arts of econometrics, my son!

If you believe the public comments made by the world’s central bankers, the prices that consumers pay for items are not rising fast enough; in some places like Europe they worry that prices might actually fall (a tragedy for the possessing classes, as their manic one-way long bets might not work then). Central bankers are terrified of this outcome. Setting aside for a second the apparent insanity of this logic for your average consumer, who experiences price rises on a near continuous basis, let’s examine…

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Categories: Economics

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