Monday, December 20, 2010

The CPI is so Yesterday

Annie Lowrey at Slate has a nice piece out on the new attempts to track prices that make the BLS statisticians, who track prices via the CPI and PPI,  look like a bunch of cavemen counting pebbles.

Lowrey specifically mentions the Billion Prices Project at MIT, that I referenced yesterday and also a project being conducted at Google.

Regarding the BPP project, Lowrey writes:
In the last few months, economists have come up with new methods for calculating inflation at Internet speed—nimbler, cheaper, faster, and perhaps even more accurate than Washington's. The first comes from the Massachusetts Institute of Technology. In 2007, economists Roberto Rigobon and Alberto Cavallo started tracking prices online and inputting them into a massive database. Then, last month, they unveiled the Billion Prices Project, an inflation measure based on 5 million items sold by 300 online retailers in 70 countries. (For the United States, the BPP collects about 500,000 prices.)

The BPP's inflation measure is markedly different from the government's. The economists just average all the prices culled online, meaning the basket of goods is whatever you can buy on the Web. (Some things, like books, are most often bought online. Some items, like cats, are not.) Plus, the researchers do not weight certain items' prices, even if they tend to make up a bigger proportion of household spending.

Still, thus far, the BPP has tracked the CPI closely. And the online-based measure has additional advantages. It comes out daily, giving a better sense of inflation's direction. It also lets researchers examine minute, day-to-day price changes. For instance, this month Rigobon and Cavallo noted that Black Friday discounts "had a smaller effect on average prices in 2010 than in 2009," contrary to reports of deeper discounting this year. And it has already produced some academic insights. For instance, Cavallo found that retailers change prices less often, but more, percentage-wise, than economists previously thought.
This is the start of some exciting work, but it has a long way to go. First and foremost it must be understood that any index is a very, very rough approximation of reality, since there are millions of prices, ever changing and ever changing quality of product, not to even mention new products.Thus, the index has to be continually "floating," which makes comparisons over long periods of time very questionable.

Second, in order to really understand prices and their influence in directing the economy, you need to understand the difference, from an Austrian perspective, in the business cycle and how consumer goods should be tracked in a different data set than capital goods. All this is as tricky as the "floating" price/product problem itself. A pencil bought by an architect, who is going to draw a building, should surely be considered a capital goods purchase, while a pencil bought by someone who wants to keep the box score at a baseball game should be considered a consumer good. Although the BLS does attempt to differentiate between durable and non-durable goods, there still needs to be much work to be done here.

There is certainly a lot of room for a Ph D student looking for a disertation topic to work in this area. It's a wide open area, where the internet and new high speed computers make for fascinating research advancement. 

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