How prices change could be the most important things that economists consider. Indeed, the Federal Reserve decides whether to flip the switch on monetary stimulus based in part on whether inflation is rising or falling. If prices are rising too quickly, they negatively impact the purchasing power of Americans, spending falls, and the economy begins to contract. That's what we saw over the past few months as energy prices rose.
Because inflation is such an important measure, calculating it accurately is vital. Yet some people complain that the government's methodologies distort reality and should be reformed. How would inflation look if its calculation was adjusted to answer one of those criticisms?
There are three major complaints about how the Bureau of Labor Statistics calculates the Consumer Price Index, which is the generally accepted measure for inflation in the U.S. First, BLS utilizes a practice called hedonics. This effectively lowers prices on goods that benefit from technological progress. Second, its estimation method assumes some substitution occurs when prices rise. For example, the calculation might assume that consumers switch to a lower grade of ground beef when prices rise. Finally, some people quibble about the product weights that the government uses for aggregate CPI, claiming that it doesn't accurately reflect actual spending.