Indexing Inflation : The Impact of Methodology on Econometrics and Macroeconomic Policy

Because there is no perfect gauge of inflation, the macroeconomic enterprise of indexing inflation ultimately dissolves into a choice among imperfect methodologies. But that choice still matters. This article will highlight the practical significance of methodological choices made in the course of indexing inflation. It will focus on two different indexes of inflation in the United States: the Consumer Price Index (CPI) and the implicit price deflator of the gross domestic product (IPD). This article identifies a long-term gap in these competing indexes' measurement of inflation. To explain why the CPI appears to overstate inflation, relative to the IPD, by roughly two-thirds of a percentage point each year, this article more fully describes the distinct methodologies underlying the CPI and the IPD. Lawmakers should adopt the implicit price deflator of the GDP, or some other inflation index that shares its best methodological features, as the best practicable measure of real growth and price change in the national economy