Cost Of Living Indices: Why Use Them?

One technical issue that comes up when looking at consumer price indices is that the concept of a “cost of living index” comes up. This is a technical definition, as opposed to the vaguely defined notion of a “cost of living” that is used in popular discussion.

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In most of my writing, I aim to explain technical concepts and debates in plain English. In this case, I am not going to attempt it. My feeling is that the specifics of this technical debate are not going to be meaningful to a general audience. Meanwhile, my attempt at explaining it may be more confusing than just reading the literature for someone with a technical background. Instead, I am just going to give a simplified explanation of why this debate happened in the first place, with just a tease of the underlying issues (as I understand it).

Note: this is a very preliminary draft of a section that follows up from an earlier piece that discusses the more vague common usage of the phrase "cost of living." This technical piece is not aimed at any current debate about inflation. The Bloomberg article referenced in the tweet below discusses the current "is what is happening now 'inflation'?" debate. 

Need for a Mathematical Methodology

The main thing to keep in mind is that statisticians and economists at national statistical agencies are tasked with calculating a consumer price index (which implies an inflation rate). They are expected to provide a number that is relatively precise, not an essay whining about how hard it is to come up with an aggregate price level. So they need to come up with a methodology (algorithm) to take price observations and turn it into a price level.

At the same time, the creation of price indices is a subject of academic inquiry. The main job of an academic is to produce new research. This means that they need to develop new algorithms, which are supposed to be better than the old ones. This means that the academic with the new algorithm starts arguing with the academics who developed the old one, generating controversy that is the fun part of academic research.

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Disclaimer: This article contains general discussions of economic and financial market trends for a general audience. These are not investment recommendations tailored to the particular needs of an ...

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