Working Paper No. 47
By Alastair W F Cunningham
This paper assesses the potential for systematic discrepancies between inflation as measured by consumer (or retail) price indices and one possible hypothetical ideal for monetary policymaking. It has long been suggested that measured price indices overstate the macro economist's view of inflation - as a result of both the weights used and the composition of the prices sampled. When monetary authorities choose to follow an explicit inflation target, the existence of a systematic upward bias between measured and 'true' inflation may affect the choice of measured target. In this paper, existing micro-level studies of bias in various components are reviewed and (where appropriate) used as the basis for extrapolation to the United Kingdom. By considering a range of assumptions, we derive a 'plausible range' of bias in inflation as measured by the UK's Retail Prices Index and its derivatives.
Measurement Bias in Price Indices: An Application to the UK's RPI