DP15663 Sources of Bias in Inflation Rates and Implications for Inflation Dynamics

Author(s): Rahel Braun, Sarah Lein
Publication Date: January 2021
Keyword(s): bias in inflation indexes, Homescan data, Inflation measurement
JEL(s): C23, C3, E31, E4, E5
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15663

Official statistics measuring the cost of living are known to suffer from several biases. This paper shows that the size of the biases can vary with economic conditions. Using homescan data, it is first confirmed that official price indexes can be tracked using such granular datasets. While the often-acknowledged substitution bias is shown to be relatively small, neglected preference adjustment and product entry/exit results in a 2.6 percentage point bias in the annual inflation rate on average. Furthermore, the bias is particularly large in the aftermath of a shock to relative prices, increasing to 3.7 percentage points.