'Are We Overestimating Inflation (Again?)'

Cecchetti & Schoenholtz:

Are we overestimating inflation (again?): Twenty years ago, a group of experts – the “Boskin Commission” – concluded that the U.S. consumer price index (CPI) systematically overstated inflation by 0.8 to 1.6 percentage points each year. Taking these findings to heart, the Bureau of Labor Statistics (BLS) got to work reducing this bias, so that by the mid-2000s, experts felt it had fallen by as much as half a percentage point.

We bring this up because there is a concern that as a consequence of the way in which we measure information technology (IT), health care, digital content and the like, the degree to which conventional indices overestimate inflation may have risen. ...

When indices like the consumer price index (CPI) or the personal consumption expenditure price index (PCE) persistently overstate inflation, there are important consequences. So long as the upward bias is constant, central bankers can (and do) modify their inflation targets. Yet, these price indexes also are used to adjust entitlement benefits without correcting for any persistent bias. And, they can have an important impact on public discourse. In particular, upward bias means that the median real wage may have risen substantially over past decades, in contrast to reported stagnation.

If the overstatement of inflation has increased during the past decade, this also has profound consequences. For one thing, the reported slowdown in annual productivity growth – from something like 2½% in the decade prior to the crisis to about 1% today – could be more apparent than real. For another, true inflation may be even further below the Federal Reserve’s long-run objective of 2% on the PCE than current readings imply.

There is good reason to think that the price mismeasurement problem has gotten worse, but quantifying that deterioration is another thing. The impact on inflation may turn out to be small – perhaps an extra ¼% annually – leaving it well within the range of uncertainty that the Boskin Commission highlighted 20 years ago. ...

After presenting their analysis, they end with:

So, what’s the bottom line? We have little doubt that inflation has been overstated for decades. That means that the rise of U.S. real output, real income, productivity, and living standards has been understated materially over the long run. In recent years, IT price mismeasurement probably has worsened this growth and productivity bias significantly. But the potential impact of IT mismeasurement on measures of consumer price inflation – which has been the source of much discussion – is small compared to what a worsening bias in health care prices would imply.

[There is a large controversy surrounding the Boskin report that I am ignoring.]