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May 11, 2020

Can inflation be accurately measured during a lockdown?

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The coronavirus pandemic has created major measurement problems for national statistical offices. Due to lockdowns in multiple countries, whole industries have been shut down and millions of goods and services that had been available to households and businesses have suddenly become unavailable. The resulting measurement problems are particularly acute for constructing the Consumer Price Index (CPI). This is the main measure of inflation and is used for multiple purposes, such as interest rate policy, and wage, business contract, and welfare payment indexation. Countries base the construction of their CPI on a fixed basket of goods that people typically buy. But with lockdowns the fixed basket has become almost totally irrelevant—we can’t buy many of those typical items. If consumer prices cannot be measured accurately, then after-inflation total consumption cannot be measured accurately either. Policymakers and the public will eventually lose confidence in such indices. This creates a crisis for policy and business decisions that rely heavily on these statistics.

The current advice from EuroStat, the International Monetary Fund, and the United Nations is for prices of the missing goods and services to be “carried forward,” that is, to use prices of goods from the most recent pre-virus period to construct inflation measures, even if the goods they are based on are unavailable now. The problem is that relying on this advice will introduce biases into economic statistics. The CPI will underestimate changes in the cost of living, and it will overstate after-inflation consumption growth. 

Another complicating factor is that national statistical offices in virus affected countries have stopped sending employees to retail outlets to collect prices. Most agencies have switched to online pricing over the internet. The prices on the internet will not be the same as in-store prices. If a statistical agency is already using scanner data from retail chains, as some agencies already do, the problem is mitigated. For other agencies and for broader categories of goods, reorganizing historical methods for collecting and processing price data will be a huge challenge. 

Estimates of GDP can be revised as improved information becomes available. However, estimates of the CPI cannot be revised due to legal difficulties with interested parties that use the CPI for contract indexation, especially many retirement payments. Once published, there is no taking back the estimates when better information becomes available. Economic statistics produced with incomplete data and methods that no longer suit their purpose can have irreversible real-world consequences.

In addition to new sources for price data, information on actual rather than historic expenditure patterns is required. The only way to produce a meaningful CPI within the lockdown period is through establishing a continuous consumer expenditure survey—measuring what and how much people are actually buying each month.

There is also a strong case for allowing the CPI to be revised as new information becomes available. At a minimum, at least one “experimental” and hence revisable CPI series should be published in addition to the CPI constructed using standard methodology. 

This is an unprecedented situation. Without urgent action to improve measurement of key economic statistics, the information needed to guide economies through and out of the current crisis will be dramatically compromised. A consequence is that economic recovery may be delayed, meaning that the economic, health, and social pain may be more prolonged than necessary.

© Erwin Diewert and Kevin J. Fox

Erwin Diewert is Professor of Economics at the Vancouver School of Economics, University of British Columbia, Canada, and at the School of Economics, UNSW Sydney, Australia. He is a Research Associate of the NBER.
Kevin J. Fox is Professor of Economics at the School of Economics, and Director of the Centre for Applied Economic Research, UNSW Sydney, Australia. He is President-Elect of the International Association for Research in Income and Wealth.

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