Abstract

The consumer price index (CPI) measures the rate at which the prices of consumer goods and services are changing over time. It is a key statistic for economic and social policymaking and has substantial and wide-ranging implications for governments, businesses, and households. This important and comprehensive Manual provides guidelines for statistical offices and other agencies responsible for constructing CPIs, and explains in-depth the methods that are used to calculate a CPI. It also examines the underlying economic and statistical concepts and principles needed for making choices in efficient and cost-effective ways, and for appreciating the full implications of those choices.

Consumer price index manual

Theory and practice

International Labour Office

International Monetary Fund

Organisation for Economic Co-operation and Development

Statistical Office of the European Communities (Eurostat)

United Nations

The World Bank

Copyright © 2004

International Labour Organization/International Monetary Fund/Organisation for Economic Co-operation and Development/Statistical Office of the European Communities/United Nations/The International Bank for Reconstruction and Development/The World Bank

First published 2004

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ILO/IMF/OECD/UNECE/Eurostat/The World Bank

Consumer price index manual: Theory and practice

Geneva, International Labour Office, 2004

Guide, consumer price index, data collecting, statistical method, calculation, methodology, developed country, developing country. 09.02

ISBN 92-2-113699-X

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FOREWORD

This volume is an expanded revision of Consumer price indices: An ILO manual, published in 1989. Through the mechanism of the Intersecretariat Working Group on Price Statistics (IWGPS), the revision has been undertaken under the joint responsibility of six international organizations: the International Labour Office (ILO); the International Monetary Fund (IMF); the Organisation for Economic Co-operation and Development (OECD); the Statistical Office of the European Communities (Eurostat); the United Nations Economic Commission for Europe (UNECE); and the World Bank. It is also being published jointly by these organizations.

The manual contains detailed comprehensive information and explanations on compiling a consumer price index (CPI). It provides an overview of the conceptual and theoretical issues that statistical offices should consider when making decisions on how to deal with the various problems in the compilation of a CPI, and is intended for use by both developed and developing countries. The chapters cover many topics; they elaborate on the different practices currently in use, propose alternatives whenever possible, and discuss the advantages and disadvantages of each alternative. Given the comprehensive nature of the manual, we expect it to satisfy the needs of many users.

The main purpose of the manual is to assist producers of consumer price indices, particularly in countries that are revising or setting up their CPIs. It draws on a wide range of experience and expertise in an attempt to describe practical and suitable measurement methods. It should also help countries to produce their CPIs in a more comparable way so that statistical offices and international organizations can make meaningful international comparisons. Bringing together a large body of knowledge on the subject, the manual may be used for self-learning, or as a teaching tool for training courses on the CPI.

Other CPI users, such as employers, workers, policy-makers and researchers, are also targeted. The manual will inform them not only about the different methods that are employed in collecting data and compiling such indices, but also of the limitations, so that the results may be interpreted correctly.

The drafting and revision have entailed many meetings over a five-year period, in which CPI experts from national statistical offices, international and regional organizations, universities and research institutes have participated. The new manual owes much to their collective advice and wisdom.

The electronic version of the manual is available on the Internet at www.ilo.org/stat. The IWGPS views the manual as a “living document” that it will amend and update to address particular points in more detail. This is especially true for emerging discussions and recommendations made by international groups reviewing the CPI, such as the International Conference of Labour Statisticians (ICLS), meetings of the International Working Group on Price Indices (the “Ottawa Group”), and the Joint UNECE/ILO Meetings on Consumer Price Indices.

Comments on the manual are welcomed by the IWGPS, and should be sent to the ILO Bureau of Statistics (e-mail: stat@ilo.org). They will be taken into account in any future revisions.

International Labour Office (ILO): A. Sylvester Young, Director, Bureau of Statistics

International Monetary Fund (IMF): Horst Koehler, Managing Director

Organisation for Economic Co-operation and Development (OECD): Enrico Giovanini, Director, Statistical Directorate

Statistical Office of the European Communities (Eurostat): Bart Meganck, Director, Economic Statistics, and Economic and Monetary Convergence

United Nations Economic Commission for Europe (UNECE): Heinrich Brüngger, Director, Statistics Division

World Bank: Shaida Badiee, Director, Development Data Group

Contents

  • Foreword

  • Preface

  • Acknowledgements

  • Reader’s guide

  • 1 An introduction to consumer price index methodology

    • The origins and uses of consumer price indices

    • Choice of index number

    • Price indices based on baskets of goods and services

      • Lowe indices

      • Laspeyres and Paasche indices

      • Decomposing current value changes using Laspeyres and Paasche indices

      • Ratios of Lowe and Laspeyres indices

      • Updated Lowe indices

      • Interrelationships between fixed basket indices

      • Young index

      • Geometric Young, Laspeyres and Paasche indices

      • Symmetric indices

      • Fixed base versus chain indices

    • Axiomatic and stochastic approaches to index numbers

      • First axiomatic approach

      • Ranking of indices using the first axiomatic approach

      • Some further tests

      • The stochastic approach and a second axiomatic approach

      • The unweighted stochastic approach

      • The weighted stochastic approach

      • A second axiomatic approach

    • Cost of living index

      • Upper and lower bounds on a cost of living index

      • Some special cases

      • Estimating COLIs by superlative indices

      • Representativity bias

      • Data requirements and calculation issues

      • Allowing for substitution

    • Aggregation issues

    • Illustrative numerical data

    • Seasonal products

    • Elementary price indices

      • Weights within elementary aggregates

      • Interrelationships between different elementary index formulae

      • Axiomatic approach to elementary indices

      • Economic approach to elementary indices

    • Concepts, scope and classifications

      • Acquisitions and uses

      • Unconditional and conditional cost of living indices

      • Specific types of transactions

      • Household production

      • Coverage of households and outlets

      • Price variation

      • Classifications

      • Consumer price indices and national accounts price deflators

    • Expenditure weights

      • Household expenditure surveys and national accounts

      • Other sources for estimating expenditure weights

    • Collection of price data

      • Random sampling and purposive sampling

      • Methods of price collection

      • Continuity of price collection

      • Resampling

    • Adjusting prices for quality changes

      • Evaluation of the effect of quality change on price

      • Implicit methods for adjusting for quality changes

      • Explicit quality adjustments

    • Item substitution and new goods

      • New goods and services

    • Calculation of consumer price indices in practice

      • Elementary price indices

      • Higher-level indices

    • Organization and management

    • Publication and dissemination

  • 2 Uses of consumer price indices

    • A range of possible consumer price indices

    • Indexation

      • Indexation of wages

      • Indexation of social security benefits

      • The type of index used for indexation

      • Indexation of interest, rents and other contractual payments

      • Taxation

    • Real consumption and real income

      • Consistency between price indices and expenditure series

      • Purchasing power parities

    • Use of the consumer price index for accounting under inflation

      • Current purchasing power accounts

      • Current cost accounting

    • Consumer price indices and general inflation

      • Consumer price indices and inflation targets

      • Consumer price indices and international comparisons of inflation

    • Popularity of consumer price indices as economic statistics

    • The need for independence and integrity of consumer price indices

  • 3 Concepts and scope

    • Introduction

    • Alternative consumption aggregates

      • Acquisitions and expenditures

      • Monetary versus non-monetary expenditures

    • Acquisitions and uses

      • Durables and non-durables

      • Consumer price indices based on acquisitions and uses

    • Basket indices and cost of living indices

      • Lowe indices

      • Cost of living indices

    • Expenditures and other payments outside the scope of consumer price indices

      • Transfers

      • Insurance

      • Gambling

      • Transactions in financial assets

    • Purchases and sales of foreign currency

    • Payments, financing and credit

      • Financial transactions and borrowing

      • The creation of a financial asset/liability

      • Hire purchase

      • Interest payments

    • Household production

      • Business activities

      • Consumption of own produce

    • Coverage of households and outlets

      • Definition of household

      • Types of household

      • Geographical coverage

      • Outlet coverage

    • Price variation

      • Price discrimination

      • Price variation between outlets

      • Outlet rotation

    • Treatment of some specific household expenditures

      • Fees of agents and brokers

      • Undesirable or illegal goods and services

      • Luxury goods and services

      • Second-hand goods

      • Imputed expenditures on goods and services

    • Price coverage

      • Taxes and subsidies

      • Discounts, rebates, loyalty schemes and “free” products

    • Classification

      • Criteria for classifying consumption expenditure

      • Classification by product type

      • Classification by purpose

      • Classifications for consumer price indices

      • Publication level

      • Classification of Individual Consumption according to Purpose (COICOP)

    • Appendix 3.1 Consumer price indices and national accounts price deflators

  • 4 Expenditure weights and their sources

    • Introduction

    • The weighting structure of the consumer price index

      • Group, class and sub-class weights

      • Regional weights

      • Outlet or outlet-type weights

      • Elementary aggregate weights

    • Data sources

      • Household expenditure surveys

      • National accounts

      • Retail sales data

      • Point-of-purchase surveys

      • Scanner data

      • Population censuses

    • Deriving the weights in practice

      • Payments that are not consumption expenditures

      • Unimportant expenditures

      • Products that are difficult to price

      • Use and combination of different sources

      • Adjusting the weights derived from household expenditure surveys

      • Weight reference period

      • Need for revising the weights

      • Frequency of updating the weights

      • Classification

      • Items requiring special treatment

      • Errors in weighting

  • 5 Sampling

    • Introduction

    • Probability sampling techniques

    • Implementing probability sampling in consumer price indices

      • Sampling techniques based on probability proportional to size

      • Sampling methods used by the US Bureau of Labor Statistics

    • Non-probability sampling techniques

      • Reasons for using non-probability sampling

      • Cut-off sampling

      • Quota sampling

      • The representative item method

      • Sampling in time

    • Choice of sampling method

    • Estimation procedures

    • Implementing estimation procedures for consumer price indices

    • Variance estimation

      • Variances of elementary index formulae

      • The United States approach

      • The Swedish approach

      • The French approach

      • The Luxembourg approach

      • Other approaches

    • Optimal allocation

    • Summary

  • 6 Price collection

    • Introduction

    • Frequency and timing of collection

      • Taking account of hyperinflation

    • Item specification

    • Collection procedures

      • Price collection techniques

      • Questionnaire design

      • Field procedures

      • Central and head office collection

      • Price reductions

      • Price bargaining

      • Forced replacements, product substitution and quality adjustment

    • Related issues

      • Electronic reporting

      • Purchasing power parities

      • Data quality and quality assurance

      • Documentation

    • Appendix 6.1 Extract from a simple price collection form

  • 7 Adjusting for quality change

    • Introduction

    • Why the matched models method may fail

      • Missing items

      • Sampling concerns

      • New products

    • The nature of quality change

      • A utility-based approach

      • Conditional indices

    • An overview of methods of quality adjustment when matched items are unavailable

      • Additive versus multiplicative adjustment

      • Base versus current period adjustment

      • Long-run versus short-run comparisons

    • Implicit methods of quality adjustment

      • Overlap

      • Overall mean or targeted mean imputation

      • Class mean imputation

      • Comparable replacement

      • Linked to show no price change

      • Carry-forward

    • Explicit methods of quality adjustment

      • Expert judgement

      • Quantity adjustment

      • Differences in production or option costs

      • Hedonic approach

      • Limitations of the hedonic approach

    • Choice between quality adjustment methods

    • High-technology and other sectors with a rapid turnover of models

      • Some examples

      • Hedonic price indices

      • The difference between hedonic indices and matched indices

      • Chaining

    • Long-run and short-run comparisons

      • Quality adjustment methods in short-run comparisons

      • Implicit short-run comparisons using imputations

      • Single-stage and two-stage indices

    • Appendix 7.1 Data on personal computers, obtained from United Kingdom Compaq and Dell web sites, July 2000, to illustrate hedonic regression

  • 8 Item substitution, sample space and new products

    • Introduction

    • Matched samples

    • Sample space and item replacement or substitution

    • Sample rotation, chaining and hedonic indices

    • Information requirements for a quality adjustment strategy

      • Statistical metadata system

    • New products and how they differ from products with quality changes

    • Incorporation of new products

      • Sample rebasing and rotation

      • Directed replacements and sample augmentation

      • Reservation prices

    • Summary

    • Appendix 8.1 Appearance or disappearance of products or outlets

    • Appendix 8.2 New goods and substitution

  • 9 Calculating consumer price indices in practice

    • Introduction

    • The calculation of price indices for elementary aggregates

      • Construction of elementary aggregates

      • Construction of elementary price indices

      • Chain versus direct indices for elementary aggregates

      • Consistency in aggregation

      • Missing price observations

      • Other formulae for elementary price indices

      • Unit value indices

      • Formulae applicable to scanner data

    • The calculation of higher-level indices

    • Consumer price indices as weighted averages of elementary indices

      • A numerical example

      • Young and Lowe indices

      • Factoring the Young index

      • Price-updating from the weight reference period to the price reference period

      • The introduction of new weights and chain linking

      • Decomposition of index changes

      • Some alternatives to fixed weight indices

    • Data editing

      • Identifying possible errors and outliers

      • Verifying and correcting data

  • 10 Some special cases

    • Introduction

    • Owner-occupied housing

      • Use

      • Payments

      • Acquisitions

    • Clothing

      • The clothing market

      • Approaches to constructing indices for non-seasonal clothing

      • Replacement of items and quality change

      • Approaches to including seasonal clothing in the consumer price index

      • Summary comments

    • Telecommunication services

      • Representative items - matched samples

      • Representative items - unit values

      • Customer profiles

      • Sample of bills

    • Financial services

      • Currency exchange

      • Stockbroking services

      • Deposit and loan facilities

    • Real estate agency services

    • Property insurance services

      • Payments

      • Use

      • Acquisitions

      • Pricing gross insurance premiums

      • Using gross premiums as a proxy for the net insurance service

    • Appendix 10.1 Calculation of a price index for a deposit product

  • 11 Errors and bias

    • Introduction

    • Types of error

      • Sampling error

      • Non-sampling error

    • Measuring error and bias

      • Estimation of variance

      • Qualitative descriptions of non-sampling errors

    • Procedures to minimize errors

    • Types of bias

    • Components of bias

      • Upper-level substitution bias

      • Elementary aggregate bias

      • Quality change and new products bias

      • New outlet bias

    • Summary of bias estimates

    • Conclusion

  • 12 Organization and management

    • Introduction

    • Local collection

      • Contracting out

      • Central collection

    • Quality in the field

      • Descriptions

      • Continuity

      • Data entry queries

      • Feedback

    • Quality checks in local collection: The role of auditors

      • Monitoring

      • Backchecking

      • Other auditor functions

    • Quality checks in head office

      • Reports

      • Algorithms

    • Producing and publishing the index

      • Monthly compilation

      • Spreadsheets

      • Introducing changes

      • Disaster recovery

    • Quality management and quality management systems

      • Quality management systems

      • Scope for greater use of quality management techniques

    • Performance management, development and training

      • Training requirements

      • Specific training for compilers and collectors

      • Documentation

      • Reviews

  • 13 Publication, dissemination and user relations

    • Introduction

    • Time series presentation of level and change

    • Seasonal adjustment and smoothing of the index

    • Analysis of contributions to change

    • Economic commentary and interpretation of the index

    • Presentation of related or alternative measures

      • Core inflation

      • Alternative indices

      • Sub-aggregate indices

    • Press release, bulletin and methodological statement

    • International standards concerning the dissemination of consumer price indices

    • Timing of dissemination of the consumer price index

    • Timeliness of release versus data accuracy

    • Access to data

    • Confidentiality

    • Electronic dissemination

    • User consultation

      • Different uses of consumer price indices

      • Presentation of methodology

      • Role of advisory committees

      • Explaining index quality

  • 14 The system of price statistics

    • Introduction

    • National accounts as a framework for the system of price statistics

      • Aggregate supply and use of goods and services

      • Institutional units and establishments

      • Accounts of institutional units

    • The consumer price index among major price indices

      • Scope of the expenditure aggregates of the consumer price index

      • The consumer price index as a measure of inflation in market transactions

      • Treatment of cross-border shopping in the consumer price index

    • Other price indicators in the national accounts

      • Price indices for total supply

      • Price indices for intermediate consumption

      • Price indices for final uses

      • Price indices for gross domestic product

      • Price indices for labour services

    • Framework for a system of price statistics for goods and services

    • International comparisons of expenditure on goods and services

  • 15 Basic index number theory

    • Introduction

    • The decomposition of value aggregates into price and quantity components

      • The decomposition of value aggregates and the product test

      • The Laspeyres and Paasche indices

    • Symmetric averages of fixed basket price indices

      • The Fisher index as an average of the Paasche and Laspeyres indices

      • The Walsh index and the theory of the “pure” price index

    • Annual weights and monthly price indices

      • The Lowe index with monthly prices and annual base year quantities

      • The Lowe index and mid-year indices

      • The Young index

    • The Divisia index and discrete approximations to it

      • The Divisia price and quantity indices

      • Discrete approximations to the continuous time Divisia index

      • Fixed base versus chain indices

    • Appendix 15.1 The relationship between the Paasche and Laspeyres indices

    • Appendix 15.2 The relationship between the Lowe and Laspeyres indices

    • Appendix 15.3 The relationship between the Young index and its time antithesis

    • Appendix 15.4 The relationship between the Divisia and economic approaches

  • 16 The axiomatic and stochastic approaches to index number theory

    • Introduction

    • The levels approach to index number theory

      • An axiomatic approach to unilateral price indices

      • A second axiomatic approach to unilateral price indices

    • The first axiomatic approach to bilateral price indices

      • Bilateral indices and some early tests

      • Homogeneity tests

      • Invariance and symmetry tests

      • Mean value tests

      • Monotonicity tests

      • The Fisher ideal index and the test approach

      • The test performance of other indices

      • The additivity test

    • The stochastic approach to price indices

      • The early unweighted stochastic approach

      • The weighted stochastic approach

    • The second axiomatic approach to bilateral price indices

      • The basic framework and some preliminary tests

      • Homogeneity tests

      • Invariance and symmetry tests

      • A mean value test

      • Monotonicity tests

      • Weighting tests

      • The Törnqvist–Theil price index and the second test approach to bilateral indices

    • The test properties of the Lowe and Young indices

    • Appendix 16.1 Proof of the optimality of the Törnqvist–Theil price index in the second bilateral test approach

  • 17 The economic approach to index number theory: The single-household case

    • Introduction

    • The Konüs cost of living index and observable bounds

    • The true cost of living index when preferences are homothetic

    • Superlative indices: The Fisher ideal index

    • Quadratic mean of order r superlative indices

    • Superlative indices: the Törnqvist index

    • The approximation properties of superlative indices

    • Superlative indices and two-stage aggregation

    • The Lloyd-Moulton index number formula

    • Annual preferences and monthly prices

      • The Lowe index as an approximation to a true cost of living index

      • A first-order approximation to the bias of the Lowe index

      • A second-order approximation to the substitution bias of the Lowe index

      • The problem of seasonal commodities

    • The problem of a zero price increasing to a positive price

  • 18 The economic approach to index number theory: The many-household case

    • Introduction

    • Plutocratic cost of living indices and observable bounds

    • The Fisher plutocratic price index

    • Democratic versus plutocratic cost of living indices

  • 19 Price indices using an artificial data set

    • Introduction

    • The artificial data set

    • Early price indices: The Carli, Jevons, Laspeyres and Paasche indices

    • Asymmetrically weighted price indices

    • Symmetrically weighted indices: Superlative and other indices

    • Superlative indices constructed in two stages of aggregation

    • Lloyd-Moulton price indices

    • Additive percentage change decompositions for the Fisher ideal index

    • The Lowe and Young indices

    • Mid-year indices based on the Lowe formula

    • Young-type indices

  • 20 Elementary indices

    • Introduction

    • Ideal elementary indices

    • Aggregation and classification problems for elementary aggregates

    • Elementary indices used in practice

    • Numerical relationships between the frequently used elementary indices

    • The axiomatic approach to elementary indices

    • The economic approach to elementary indices

    • The sampling approach to elementary indices

    • The use of scanner data in constructing elementary aggregates

    • A simple stochastic approach to elementary indices

    • Conclusion

  • 21 Quality change and hedonics

    • Introduction

    • New and disappearing items

    • Hedonic prices and implicit markets

      • Items as tied bundles of characteristics

      • The consumer or demand side

      • The producer or supply side

      • Equilibrium

      • What hedonic prices mean

      • An alternative, consumer-based hedonic theoretical formulation

    • Hedonic indices

      • Theoretical characteristics price indices

      • Hedonic regressions and dummy variables of time

      • Hedonic imputation indices

      • Superlative and exact hedonic indices

      • Unweighted hedonic indices and unweighted matched index number formulae

    • New goods and services

    • Appendix 21.1 Some econometric issues

  • 22 The treatment of seasonal products

    • Introduction

    • A seasonal commodity data set

    • Year-over-year monthly indices

    • Year-over-year annual indices

    • Rolling year annual indices

    • Predicting a rolling year index using a current period year-over-year monthly index

    • Maximum overlap month-to-month price indices

    • Annual basket indices with carry forward of unavailable prices

    • Annual basket indices with imputation of unavailable prices

    • Bean and Stine Type C or Rothwell indices

    • Forecasting rolling year indices using month-to-month annual basket indices

    • Conclusion

  • 23 Durables and user costs

    • Introduction

    • The acquisitions approach

    • The rental equivalence approach

    • The user cost approach

    • The relationship between user costs and acquisition costs

    • Alternative models of depreciation

      • A general model of depreciation for (unchanging) consumer durables

      • Geometric or declining balance depreciation

      • Straight line depreciation

      • “One hoss shay” or light bulb depreciation

    • Unique durable goods and the user cost approach

    • The user cost of owner-occupied housing

    • The treatment of costs that are tied to owner-occupied housing

      • The treatment of mortgage interest costs

      • The treatment of property taxes

      • The treatment of property insurance

      • The treatment of maintenance and renovation expenditures

      • The treatment of the transactions costs of home purchase

    • User costs for landlords versus owners

      • Damage costs

      • Non-payment of rent and vacancy costs

      • Billing and maintenance costs

      • The opportunity cost of capital

      • The supply of additional services for rented properties

    • The payments approach

    • Alternative approaches for pricing owner-occupied housing

      • The acquisitions approach

      • The rental equivalence approach

      • The user cost approach

    • A glossary of main terms

      • Appendix to the glossary. Some basic number formulae and terminology

    • Annex 1 Harmonized Indices of Consumer Prices (European Union)

    • Annex 2 Classification of Individual Consumption according to Purpose (COICOP)-Extract

    • Annex 3 Resolution concerning consumer price indices adopted by the Seventeenth International Conference of Labour Statisticians, 2003

    • Annex 4 Spatial comparisons of consumer prices, purchasing power parities and the International Comparison Program

    • Bibliography

    • Index

  • List of tables

    • 4.1 Example of weights by region and outlet type for the sub-class “fresh fruit”

    • 5.1 Systematic sample of 3 out of 10 outlets, based on probability proportional to size

    • 5.2 Pareto sample of 3 out of 10 outlets, based on probability proportional to size

    • 6.1 Example of a survey form showing the number of price quotations by shop or stall

    • 6.2 Example illustrating the method for determining the actual price paid by the purchaser when bargaining takes place

    • 7.1 Example of the implicit methods of quality adjustment

    • 7.2 Example of the bias from implicit quality adjustment when the (mean) price change of quality-adjusted new items compared with the items they are replacing is assumed not to change (r2= 1.00)

    • 7.3 Example of size, price and unit price of bags of flour

    • 7.4 Hedonic regression results for Dell and Compaq personal computers

    • 7.5 Example of long-run and short-run comparisons

    • 8.1 Example of sample augmentation

    • 9.1 Calculation of price indices for an elementary aggregate

    • 9.2 Imputation of temporarily missing prices

    • 9.3 Disappearing items and their replacements with no overlap

    • 9.4 Disappearing and replacement items with overlapping prices

    • 9.5 The aggregation of elementary price indices

    • 9.6 Price-updating of weights between the weight and price reference periods

    • 9.7 Calculation of a chain index

    • 9.8 Decomposition of index changes

    • 10.1 Calculation of a mortgage debt series

    • 10.2 Calculation of a mortgage interest charges series

    • 10.3 Synthetic price data to illustrate approaches to constructing clothing price indices

    • 10.4 Alternative price indices for summer seasonal clothing

    • 10.5 Alternative price indices for winter seasonal clothing

    • 10.6 Alternative price indices for total clothing

    • 10.7 An illustrative index structure for telecommunication services (representative item approach)

    • 10.8 Examples of specifications of telecommunication services

    • 10.9 Example of a user profile for mobile phone services

    • 10.10 Illustration of the impact of taxes on measures of insurance services

    • 11.1 A taxonomy of errors in a consumer price index

    • 14.1 Production account for an establishment, institutional unit or institutional sector

    • 14.2 Production account with product detail for an establishment or local kind of activity unit

    • 14.3 Use of income account for institutional units and sectors

    • 14.4 Use of income account with product detail for institutional units and sectors

    • 14.5 Use of income account with product detail for the total economy

    • 14.6 Capital account

    • 14.7 Capital account with product detail

    • 14.8 External account of goods and services

    • 14.9 External account of goods and services with product detail

    • 14.10 The supply and use table (SUT)

    • 14.11 Location and coverage of major price indices: Columns in the supply and use table

    • 14.12 Definition of scope, price relatives, coverage and weights for major price indices

    • 14.13 Generation of income account for establishment, institutional unit or institutional sector

    • 14.14 Generation of income account for establishment and industry with labour services (occupational) detail

    • 14.15 A framework for price statistics

    • 19.1 Prices for six commodities

    • 19.2 Quantities for six commodities

    • 19.3 Expenditures and expenditure shares for six commodities

    • 19.4 The fixed base Laspeyres, Paasche, Carli and Jevons indices

    • 19.5 Chain Laspeyres, Paasche, Carli and Jevons indices

    • 19.6 Asymmetrically weighted fixed base indices

    • 19.7 Asymmetrically weighted indices using the chain principle

    • 19.8 Asymmetrically weighted fixed base indices for commodities 3–6

    • 19.9 Asymmetrically weighted chained indices for commodities 3–6

    • 19.10 Symmetrically weighted fixed base indices

    • 19.11 Symmetrically weighted indices using the chain principle

    • 19.12 Fixed base superlative single-stage and two-stage indices

    • 19.13 Chained superlative single-stage and two-stage indices

    • 19.14 Chained Fisher and fixed base Lloyd-Moulton indices

    • 19.15 Chained Fisher and chained Lloyd-Moulton indices

    • 19.16 Diewert’s additive percentage change decomposition of the Fisher index

    • 19.17 Van Ijzeren’s decomposition of the Fisher price index

    • 19.18 The Lowe and Young indices, the fixed base Laspeyres, Paasche and Fisher indices, and the chained Laspeyres, Paasche and Fisher indices

    • 19.19 The five Lowe indices, the mid-year index, and the Törnqvist and Fisher chain indices

    • 19.20 The five Young-type indices and the Törnqvist and Fisher chain indices

    • 20.1 Proportion of transactions in 2000 that could be matched to 1998

    • 20.2 Laspeyres price indices by type of classification, September 1998-September 2000

    • 20.3 Fisher price indices by type of classification, September 1998-September 2000

    • 22.1 An artificial seasonal data set: Prices

    • 22.2 An artificial seasonal data set: Quantities

    • 22.3 Year-over-year monthly fixed base Laspeyres indices

    • 22.4 Year-over-year monthly fixed base Paasche indices

    • 22.5 Year-over-year monthly fixed base Fisher indices

    • 22.6 Year-over-year approximate monthly fixed base Paasche indices

    • 22.7 Year-over-year approximate monthly fixed base Fisher indices

    • 22.8 Year-over-year monthly chained Laspeyres indices

    • 22.9 Year-over-year monthly chained Paasche indices

    • 22.10 Year-over-year monthly chained Fisher indices

    • 22.11 Year-over-year monthly approximate chained Laspeyres indices

    • 22.12 Year-over-year monthly approximate chained Paasche indices

    • 22.13 Year-over-year monthly approximate chained Fisher indices

    • 22.14 Annual fixed base Laspeyres, Paasche and Fisher price indices

    • 22.15 Annual approximate fixed base Laspeyres, Paasche, Fisher and geometric Laspeyres indices

    • 22.16 Annual chained Laspeyres, Paasche and Fisher price indices

    • 22.17 Annual approximate chained Laspeyres, Paasche and Fisher price indices

    • 22.18 Rolling year Laspeyres, Paasche and Fisher price indices

    • 22.19 Rolling year approximate Laspeyres, Paasche and Fisher price indices

    • 22.20 Rolling year fixed base Laspeyres and seasonally adjusted approximate rolling year price indices

    • 22.21 Month-to-month maximum overlap chained Laspeyres, Paasche and Fisher price indices

    • 22.22 Month-to-month chained Laspeyres, Paasche and Fisher price indices

    • 22.23 Lowe, Young, geometric Laspeyres and centred rolling year indices with carry forward prices

    • 22.24 Lowe, Young, geometric Laspeyres and centred rolling year indices with imputed prices

    • 22.25 The Lowe with carry forward prices, Rothwell and normalized Rothwell indices

    • 22.26 Seasonally adjusted Lowe, Young and geometric Laspeyres indices with carry forward prices and the centred rolling year index

    • 22.27 Seasonally adjusted Lowe, Young and geometric Laspeyres indices with imputed prices, seasonally adjusted Rothwell and centred rolling year indices

  • List of figures

    • 4.1 Typical aggregation structure of a consumer price index (CPI)

    • 6.1 Price collection procedures

    • 7.1 Quality adjustment for different-sized items

    • 7.2 Scatter diagram showing prices and processing speeds of personal computers

    • 7.3 Flowchart for making decisions on quality change

    • 9.1 Typical aggregation structure of a consumer price index (CPI)

    • 12.1 Price collection procedures

    • 17.1 The Laspeyres and Paasche bounds to the true cost of living index

    • 21.1 Consumption and production decisions for combinations of characteristics

    • 22.1 Rolling year fixed base and chained Laspeyres, Paasche and Fisher indices

    • 22.2 Rolling year approximate fixed base and chained Laspeyres, Paasche and Fisher indices

    • 22.3 Fixed base Laspeyres, seasonally adjusted approximate and approximate rolling year indices

    • 22.4 Lowe, Young, geometric Laspeyres and centred rolling year Laspeyres indices

    • 22.5 Lowe, Young and geometric Laspeyres with imputed prices and centred rolling year indices

    • 22.6 The Lowe and Rothwell price indices

    • 22.7 Seasonally adjusted Lowe, Young and geometric Laspeyres indices with carry forward prices and the centred rolling year index

    • 22.8 Seasonally adjusted Lowe, Young and geometric Laspeyres indices with imputed prices, seasonally adjusted Rothwell and centred rolling year indices

    • A4.1 A minimum spanning tree: Europe

    • A4.2 Price data for CPI and ICP activities

    • A4.3 A sequence of price comparisons

  • List of boxes

    • 13.1 Model presentation of consumer price index

    • 13.2 Model note on methodology - to be included in press releases on consumer price indices

    • 14.1 Institutional sectors in the System of National Accounts 1993

    • 14.2 Coverage of industries or activities by the producer price index in terms of aggregate output value

    • 14.3 Treatment of housing and consumer durables in the system of national accounts and in consumer price indices

PREFACE

The International Labour Office (ILO), the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), the Statistical Office of the European Communities (Eurostat), the United Nations Economic Commission for Europe (UNECE) and the World Bank, together with experts from a number of national statistical offices and universities, have collaborated since 1998 on developing this manual. The sponsoring organizations endorse the principles and recommendations contained in it as good practice for statistical agencies in compiling their consumer price indices (CPIs). Because of practical and resource constraints, however, some of the current recommendations may not be immediately attainable by all statistical offices, and they should therefore serve as guidelines or targets for agencies as they revise their CPIs and improve their CPI programmes. There are not always clear-cut solutions to specific conceptual and practical problems such as sample design, choice of index formula, adjustment of prices for quality changes, and the treatment of new products. Statistical offices must therefore rely on the underlying economic and statistical principles laid out in this manual to arrive at practical solutions.

The consumer price index

The CPI is an index that measures the rate at which the prices of consumption goods and services are changing from month to month (or from quarter to quarter). The prices are collected from shops or other retail outlets. The usual method of calculation is to take an average of the period-to-period price changes for the different products, using as weights the average amounts that households spend on them. CPIs are official statistics that are usually produced by national statistical offices, ministries of labour or central banks. They are published as quickly as possible, typically about ten days after the end of the most recent month or quarter.

The manual is intended for the benefit of users of CPIs, as well as for the statistical agencies that compile the indices. It is designed to do two things. First, it explains in some detail the methods that are actually used to calculate a CPI. Second, it explains the underlying economic and statistical theory on which the methods are based.

A CPI measures the rate of price inflation as experienced and perceived by households in their role as consumers. It is also widely used as a proxy for a general index of inflation for the economy as a whole, partly because of the frequency and timeliness with which it is produced. It has become a key statistic for purposes of economic policy-making, especially monetary policy. It is often specified in legislation and in a wide variety of private contracts as the appropriate measure of inflation for the purposes of adjusting payments (such as wages, rents, interest and social security benefits) for the effects of inflation. It can therefore have substantial and wide-ranging financial implications for governments and businesses, as well as for households.

This manual provides guidelines for statistical offices or other agencies responsible for constructing a CPI, bearing in mind that the resources available for this purpose are limited. Calculating a CPI cannot be reduced to a simple set of rules or standard set of procedures that can be mechanically followed in all circumstances. While there are certain general principles that may be universally applicable, the procedures followed in practice, whether they concern the collection or processing of the prices or the methods of aggregation, have to take account of particular circumstances. These include the main use of the index, the nature of the markets and pricing practices within the country, and the resources available to the statistical office. Statistical offices have to make choices. The manual explains the underlying economic and statistical concepts and principles needed to enable statistical offices to make their choices in efficient and cost-effective ways and to be aware of the full implications of their choices.

The manual draws upon the experience of many statistical offices throughout the world. The procedures they use are not static, but continue to evolve and improve in response to several factors. First, research continually refines and strengthens the economic and statistical theory underpinning CPIs. For example, clearer insights have recently been obtained on the relative strengths and weaknesses of the various formulae and methods used to process the basic price data collected for CPI purposes. Second, recent advances in information and communications technology have affected CPI methods. Both of these theoretical and data developments can impinge on all the stages in compiling a CPI. New technology can affect the methods used to collect prices and transmit them to the central statistical office. It can also improve the processing and checking, including the methods used to adjust prices for changes in the quality of the goods and services covered. Finally, improved formulae help in calculating more accurate and reliable higher-level indices, including the overall CPI itself.

International standards for CPIs

Some international standards for economic statistics have evolved primarily in order to enable internationally comparable statistics to be compiled. However, individual countries also stand to benefit from international standards. The CPI standards described in this manual draw upon the collective experience and expertise accumulated in many countries. All countries can benefit by having easy access to this experience and expertise.

In many countries, CPIs were first compiled mainly in order to be able to adjust wages to compensate for the loss of purchasing power caused by inflation. Consequently, the responsibility for compiling CPIs was often entrusted to ministries, or departments, of labour. The International Conference of Labour Statisticians (ICLS), convened by the Governing Body of the ILO, therefore provided the natural forum in which to discuss CPI methodology and develop guidelines.

The first international standards for CPIs were promulgated in 1925 by the Second ICLS. The first set of standards referred to “cost of living” indices rather than CPIs. A distinction is now drawn between two different types of index. A consumer price index can be defined simply as measuring the change in the cost of purchasing a given “basket” of consumption goods and services, whereas a cost of living index is defined as measuring the change in the cost of maintaining a given standard of living, or level of utility. For this reason, the Tenth ICLS in 1962 decided to adopt the more general term “consumer price index”, which should be understood to embrace both concepts. There need be no conflict between the two. As explained in the manual, the best-practice methods are likely to be very similar, whichever approach is adopted.

The international standards have been revised three times, in 1947, 1962 and 1987, in the form of resolutions adopted by the ICLS. The 1987 standards on CPI were followed by a manual on methods (Turvey, 1989), which provided guidance to countries on the practical application of the standards.

The background to the present revision

A few years after the publication of the 1989 ILO manual, it became clear that a number of outstanding and controversial methodological problems needed further investigation and analysis. An expert group was formed consisting of specialists in price indices from national statistical offices, international organizations and universities from around the world. It met for the first time in Ottawa in 1994, and became known as the “Ottawa Group”, one of the city groups established by the United Nations Statistical Commission to address selected problems in statistical methods. During the course of seven meetings of the Ottawa Group between 1994 and 2003, over 100 research papers on the theory and practice of price indices were presented and discussed. One outcome was that it became apparent that existing CPI methods could be improved and strengthened in a number of ways.

At the same time, the control of inflation had become a high-priority policy objective in most countries. Not only is the CPI widely used to measure and monitor inflation, but inflation targets in many countries are set specifically in terms of a precise rate of change in the CPI. The slowing down of inflation in many parts of the world in the 1990s, as compared with the 1970s and 1980s, far from reducing interest in CPI methodology, actually stimulated a demand for more accurate, precise and reliable measures of inflation. When the rate of inflation slows to only 2 or 3 per cent per year, even a small error or bias in the CPI becomes relatively significant.

In order to be sure about the accuracy of CPIs, governments or research institutes in a few countries commissioned special groups of experts to investigate and evaluate the methods used. The methodology used to calculate CPIs was subjected to public interest and scrutiny unknown in the past. One conclusion reached was that existing methods might lead to some upward bias. Many academic and government economists and other users of CPIs became convinced of this, believing that insufficient allowance was being made for improvements in the quality of many goods and services. In fact, the extent and sometimes even the direction of such bias are uncertain. It will also, of course, vary between different types of consumption goods and services, and its total effect on the overall CPI will vary between countries. However, the bias is potentially large. For this reason, this manual addresses in some detail the issue of adjusting prices for changes in quality, drawing upon the most recent research in this area. There are other sources of possible bias, such as that resulting from working with an out-of-date and unrepresentative basket of goods and services. Bias may also result from the sampling and price collection methods used. Several chapters deal with these issues, with an overall summary of possible errors and biases given in Chapter 11.

CPIs are widely used for the index linking of social benefits such as pensions, unemployment benefits and other government payments, and also as escalators for adjusting prices in long-term contracts. The cumulative effects of even a small bias could be substantial over the long term and could have considerable financial consequences for government budgets. Government agencies, especially ministries of finance, have therefore taken a renewed interest in CPIs, examining their accuracy and reliability more closely and carefully than in the past.

In response to the various developments outlined above, the need to revise, update and expand the 1989 ILO manual was gradually recognized and accepted during the late 1990s. A formal recommendation to revise the manual was made at the joint UNECE/ILO Meeting on Consumer Price Indices, held in Geneva at the end of 1997. Responsibility for the revision was entrusted to the main international organizations interested in the measurement of inflation. This strategy was endorsed in 1998 by the United Nations Statistical Commission, which also agreed to the conversion of the Ottawa Group into a formal Intersecretariat Working Group on Price Statistics (IWGPS). The Sixteenth ICLS, meeting in 1998, also recommended that the Fourteenth ICLS resolution concerning consumer price indices, adopted in 1987, should be revised. The preparation of the draft revised resolution discussed at the Seventeenth ICLS (24 November-3 December 2003) was carried out by the ILO Bureau of Statistics in parallel with the preparation of this revised manual. Every effort has been made to ensure that the two documents are consistent and mutually supportive.1

Some concerns about current index methods

This new manual takes advantage of the wealth of new research on index number theory and methods in the last decade to address the kinds of concerns referred to above. It recommends some new practices and its purpose is not simply to codify existing statistical agency practices. It is useful to highlight a few of the main concerns that have led to many topics being dealt with in some depth in the manual.

The traditional standard methodology underlying a typical CPI is based on the concept of a Laspeyres price index. A Laspeyres index measures the change between two periods of time in the total cost of purchasing a basket of goods and services that is representative of the first, or base, period. The base period basket of consumer purchases is priced first at base period prices and then repeatedly priced at the prices of successive time periods. This methodology has at least three practical advantages. It is easily explained to the public; it can make repeated use of the same data on consumer purchases that date from some past household survey or administrative source (rather than requiring new data each month); and it need not be revised, assuming users are satisfied with the Laspeyres concept. Another notable advantage is that the Laspeyres is consistent in aggregation down to the lowest level of aggregation. The index can be broken down into sub-aggregates that are interrelated in a simple way.

Statistical agencies actually calculate their CPIs by implementing the Laspeyres index in its alternative form as a weighted average of the observed price changes, or price relatives, using the base period expenditure shares as weights. Unfortunately, although the Laspeyres is a simple concept, it is difficult to calculate a proper Laspeyres index in practice. Consequently, statistical agencies have to resort to approximations:

  • It is generally impossible to obtain accurate expenditure shares for the base period at the level of individual commodities, so statistical agencies settle for getting base period expenditure weights at the level of 100–1,000 product groups.

  • For each of the chosen product groups, agencies collect a sample of representative prices from outlets rather than attempting to collect every single transaction price. They use equally weighted (rather than expenditure-weighted) index formulae to aggregate these elementary product prices into an elementary aggregate index, which will in turn be used as the price relative for each of the 100–1,000 product groups when calculating the higher-level Laspeyres index. It is recognized that this two-stage procedure is not entirely consistent with the Laspeyres methodology (which requires weighting at each stage of aggregation). However, for a number of theoretical and practical reasons, statistical agencies judge the resulting elementary index price relatives to be sufficiently accurate to insert into the Laspeyres formula at the higher stage of aggregation.

This methodology dates back to the work of Mitchell (1927) and Knibbs (1924), and other pioneers who introduced it 80 or 90 years ago, and it is still used today.

Although most statistical agencies have traditionally used the Laspeyres index as their target index, both economic and index number theory suggest that some other types of indices may be more appropriate target indices to aim at: namely, the Fisher, Walsh or Törnqvist–Theil indices. As is well known, the Laspeyres index has an upward bias compared with these target indices. Of course, these target indices may not be achievable by a statistical agency, but it is necessary to have some sort of theoretical target to aim at. Having a target concept is also necessary so that the index that is actually produced by a statistical agency can be evaluated to see how close it comes to the theoretical ideal. In the theoretical chapters of the manual, four main approaches to index number theory are described:

  • (1) fixed basket approaches and symmetric averages of fixed baskets;

  • (2) the stochastic (statistical estimator) approach to index number theory;

  • (3) test (axiomatic) approaches; and

  • (4) the economic approach.

Approaches (3) and (4) will be familiar to many price statisticians and expert users, but perhaps a few words about approaches (1) and (2) are in order.

The Laspeyres index is an example of a basket index. The concern from a theoretical point of view is that there is an equally valid alternative for the two periods being compared: the Paasche index, which uses the basket of quantities from the current period. If there are two equally valid estimators for the same concept, then statistical theory suggests taking an average of the two. However, there is more than one kind of average and the question of which average to take is not trivial. The manual proposes that the “best” average is the geometric average of the Laspeyres and Paasche indices (the Fisher ideal). Alternatively, the “best” basket is one whose quantities are geometric averages of the quantities in both periods (the Walsh index). From the statistical estimation perspective, the “best” index number is a geometric average of the price relatives that uses the (arithmetic) average expenditure share in two periods as weights (the Törnqvist–Theil index).

One additional result from index number theory should be mentioned here: the problem of defining the price and quantity of a product that should be used for each period in the index number formula. The problem is that the same product may be sold at a number of different prices. So the question arises, what price would be most representative of the sales of this product for the period? The answer is the unit value, since this price multiplied by the total quantity sold during the period equals the value of sales. Of course, the manual does not endorse taking unit values over heterogeneous products; unit values should only be calculated for identical products.

Six main areas of concern with the standard methodology are listed below. They are not ranked in order of importance, and all are considered to be important:

  1. At the final stage of aggregation, a conventional CPI is not a true Laspeyres index since the expenditure weights pertain to a reference base year that is different from the base month (or quarter) for prices. Thus, the expenditure weights are annual whereas the prices are collected monthly. To be a true Laspeyres index, the period that provides the expenditure weights must coincide with the reference period for the prices. In fact, the index actually calculated by many statistical agencies at the last stage of aggregation has a weight reference period that precedes the base price period. Indices of this type are likely to have some upward bias compared to a true Laspeyres index, especially if the expenditure weights are price-updated from the weight reference period to the Laspeyres base period. It follows that they must have definite upward biases compared to theoretical target indices such as the Fisher, Walsh or Törnqvist–Theil indices.

  2. At the early stages of aggregation, unweighted averages of prices or price relatives are used. Until recently, when scanner data from electronic points of sale became more readily available, it was thought that the biases that might result from the use of unweighted indices were not particularly significant. However, recent evidence suggests that there is potential for significant upward bias at lower levels of aggregation compared to results that are generated by the preferred target indices mentioned above.

  3. The third major concern with standard CPI methodology is that, although statistical agencies generally recognize that there is a problem with the treatment of quality change and new goods, it is difficult to work out a coherent methodology for these problems in the context of a Laspeyres index that uses a fixed set of quantities. The most widely received good practice in quality adjusting price indices is “hedonic regression”, which characterizes the price of a product at any given time as a function of its physical and economic characteristics as compared with substitutes. In fact, there is a considerable amount of controversy on how to integrate hedonic regression methodology into the CPI’s theoretical framework. Both the theoretical and the more practically oriented chapters in the manual devote a lot of attention to these methodological issues. The problems created by the disappearance of old, and the appearance of new, products are now much more severe than they were when the traditional CPI methodology was developed some 80 years ago (when the problem was mostly ignored). For many categories of products, such as models of consumer durables, those priced at the beginning of the year are simply no longer available by the end of the year. Sample attrition creates tremendous methodological problems. At lower levels of aggregation, it becomes necessary (at least in many product groups) to use chained indices rather than fixed base indices. Certain unweighted indices are liable to have substantial bias when chained.

  4. A fourth major area of concern is related to the first: that is, the treatment of seasonal commodities. The use of annual quantities or annual expenditure shares is justified to a certain extent if one is interested in the longer-run trend of price changes. However, some users, such as central banks, focus on short-term, month-to-month changes, in which case the use of annual weights can lead to misleading signals. Monthly price changes for products that are out of season (i.e., the seasonal weights for the product class are small for those months) can be greatly magnified by the use of annual weights. The problem is worse when the products are not available at all at certain months of the year. There are solutions to these seasonality problems, but they may not appeal to many CPI compilers and users since they involve the construction of two indices: one for the short-term measurement of price changes and another (more accurate) longer-term index that is adjusted for seasonal influences.

  5. A fifth concern with standard CPI methodology is that, in common with most economic statistics, services have been comparatively neglected in CPIs, notwithstanding the fact that they have become extremely important. A typical CPI will collect many more goods prices than services prices and will have many more product groups for goods rather than services. Traditionally, there has not been much focus on the problems involved in measuring price and quantity changes for services, even though they raise serious conceptual and practical problems. Some examples of difficult-to-measure services are: insurance, gambling, financial services, advertising, telecommunications, entertainment and housing services. In many cases, statistical agencies simply do not have the resources or methodologies at their disposal to deal adequately with these difficult measurement problems.

  6. A final concern with existing CPI methodology is that it tends not to recognize that more than one CPI may be required to meet the needs of different users. For example, some users may require information on the month-to-month movement of prices in a timely fashion. This requires a basket index with predetermined (even though possibly inappropriate and out-of-date) weights that are instantly available. However, other users may be more interested in a more accurate or representative measure of price change and may be willing to sacrifice timeliness for increased accuracy. For this reason, the United States Bureau of Labor Statistics provides, on a retrospective basis, a superlative index that uses both current and base period weight information in a symmetrical way. This is an entirely reasonable development, recognizing that different users have different needs. A second example where more than one index might be compiled relates to owner-occupied housing. Good cases have been made for three different treatments: the acquisitions approach, the rental equivalence approach and the user cost approach. However, these three approaches may give quite different numerical results in the short run. A statistical agency has to opt for one approach, but since all three command support, indices using the other two approaches could be made available as analytical series for interested users. A third example of where more than one index would be useful occurs when, because of seasonal commodities, the month-to-month index may not be based on the same set of products as one that compares the month with the same month a year earlier.

The above kinds of concern are addressed in this manual. Frank discussions of these matters should stimulate the interest of professional economists and statisticians in universities, government departments, central banks, and so on, to address these measurement problems and to provide new solutions that can be used by statistical agencies. Public awareness of these areas should also heighten awareness of the need for additional resources to be allocated to statistical agencies so that economic measurement will be improved.

The Harmonized Indices of Consumer Prices

Within the European Union (EU), the convergence of inflation in Member States was an important prerequisite for the formation of a monetary union in 1999. This required a precisely defined measure of inflation and an agreed methodology to ensure that the different countries’ price indices are comparable. A detailed and systematic review of all aspects of the compilation of CPIs was therefore undertaken during the 1990s by all the national statistical offices of the EU Member States in collaboration with Eurostat, the Statistical Office of the EU. This work culminated in the elaboration of a new EU standard for the 29 Member and candidate States, and led to the development of the EU’s Harmonized Indices of Consumer Prices (HICPs). A summary of HICP methodology is given in Annex 1 to this manual.

Work on the HICPs proceeded in parallel with that of the IWGPS, many of whose experts also participated both in work on the HICPs and in the present revision of this manual. Although the methodology elaborated here has much in common with that adopted for the HICPs, there are also differences. The HICPs were developed for a very specific purpose, whereas the methodology developed in this manual is intended to be flexible, multi-purpose and applicable to all countries, whatever their economic circumstances and level of development. The manual also provides considerably more detail, information, explanation and rationalization of CPI methodology and the associated economic and statistical theory than is to be found in the HICP standards.

The organization of the revision

The six international organizations listed at the beginning of this preface, concerned with both the measurement of inflation and policies designed to control it, have collaborated on the revision of this manual. They have provided, and continue to provide, technical assistance on CPIs to countries at all levels of development, including those in transition from planned to market economies. They joined forces for the revision of this manual, establishing the IWGPS for the purpose. The role of the IWGPS was to organize and manage the process rather than act as an expert group.

The responsibilities of the IWGPS were to:

  • appoint the various experts on price indices who participated in the revision process, either as members of the Technical Expert Group (TEG/CPI), providing substantive advice on the content of the manual, or as authors;

  • provide the financial and other resources needed;

  • arrange meetings of the TEG/CPI, prepare the agendas and write the reports of the meetings; and

  • arrange for the publication and dissemination of the manual.

Members of the IWGPS were also members of the TEG/CPI. It is important to note that the experts participating in the TEG/CPI were invited in their personal capacity as experts and not as representatives, or delegates, of the national statistical offices or other agencies in which they might be employed. Participants were able to give their expert opinions without in any way committing the offices from which they came.

The revision of the manual took five years, and involved multiple activities:

  • the development of the manual outline and the recruitment of experts to draft the various chapters;

  • the review of the draft chapters by the members of the TEG/CPI, the IWGPS and other experts;

  • the posting of the draft chapters on a special web site for comment by interested individuals and organizations;

  • discussions by a small group of experts from statistical agencies and universities on the finalization of all the chapters;

  • final copy-editing of the whole manual.

Links with the Producer price index manual

One of the first decisions of the IWGPS was that a new international manual on producer price indices (PPIs) should be produced simultaneously with this manual. Whereas there have been international standards for CPIs for over 70 years, the first international manual on producer price indices was not produced until 1979 (United Nations, 1979). Despite the importance of PPIs for measuring and analysing inflation, the methods used to compile them have been comparatively neglected, at both national and international levels.

A new Producer price index manual (ILO, IMF, OECD, Eurostat, UNECE and the World Bank, forthcoming) has therefore been developed and written in parallel with this manual. The IWGPS established a second Technical Expert Group on PPIs whose membership overlapped with that of the Technical Expert Group on CPIs. The two groups worked in close liaison with each other. The methodologies of PPIs and CPIs have much in common. Both are based on essentially the same underlying economic and statistical theory, except that the CPI draws on the economic theory of consumer behaviour whereas the PPI draws on the economic theory of production. However, the two economic theories are isomorphic and lead to the same kinds of conclusions with regard to index number compilation. The two manuals have similar contents and are fully consistent with each other conceptually, sharing common text when appropriate.

Most members of the Technical Expert Groups on CPIs and PPIs also participated as active members of the Ottawa Group. The two manuals were able to draw upon the contents and conclusions of all the numerous papers presented at meetings of the Group.

ACKNOWLEDGEMENTS

The organizations of the IWGPS wish to thank all those involved in the drafting and production of the manual. Particular thanks go to Peter Hill, the editor, W. Erwin Diewert, who contributed extensively to the theoretical chapters of the manual, and Bert Balk, who acted as referee for all the theoretical chapters. Their efforts greatly enhanced the quality of the manual.

The authors of the chapters are as follows:

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The affiliations of the authors are as follows:

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The manual has also benefited from valuable contributions by many other experts, including: Martin Boon (Statistics Netherlands); Heber Camelo and Ernestina Pérez (Economic Commission for Latin America and the Caribbean); Denis Fixler (United States Bureau of Economic Analysis); Leendert Hoven (Statistics Netherlands); Michel Mouyelo-Katoula (African Development Bank); Carl Obst (formerly OECD); Bouchaib Thich (Departement de la prevision economique et du plan, Morocco); and Ralph Turvey (expert). The following also gave helpful advice and comments: Statistics Austria; Statistics Singapore; United States BLS; Michael Anderson (ABS); Rob Edwards (ABS); Eivind Hoffmann (ILO); participants at the International Workshop on Consumer Price Indices, Singapore, June 2001; and the members of the Ottawa Group.

The IWGPS established the Technical Expert Group on the CPI (TEG/CPI) for the revision of the manual. Members of the IWGPS were also members of the TEG/CPI, whose individual members were:

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The UNECE (Jan Karlsson, Lidia Bratanova*, Miodrag Pesut*, Tihomira Dimova*) and the ILO (Valentina Stoevska) jointly acted as the Secretariat of the TEG/CPI.

The TEG/CPI met seven times: 11–12 February 1999 (Geneva), 2 November 1999 (Geneva), 5–6 February 2001 (Washington, DC), 25–26 June 2001 (Geneva), 31 October 2001 (Geneva), 19–21 March 2002 (London) and 14–15 October 2002 (London).

The IWGPS met formally five times: 24 September 1998 (Paris), 11 February 1999 (Geneva), 2 November 1999 (Geneva), 21–22 March 2002 (London) and 5 December 2003 (Geneva). A number of informal meetings were also held.

The ILO was the Secretariat of the Group and A. Sylvester Young the chairperson of the IWGPS. During the revision of the manual, the CPI manual editor (Peter Hill), the TEG-CPI chairperson (David Fenwick), the PPI manual editor and the TEG/PPI chairperson (Paul Armknecht) participated in the meetings of the IWGPS.

The final publication of the English version of this manual was coordinated, with the involvement of the IWGPS member organizations, by Valentina Stoevska of the ILO Bureau of Statistics. The ILO Bureau of Publications provided extensive editorial and support services for the production process. We should also like to thank Angela Haden and Barbara Campanini for their thorough copy-editing of the final draft.

READER’S GUIDE

International manuals in the field of economic statistics have traditionally been intended to provide guidance about concepts, definitions, classifications, coverage, valuation, the recording of data, aggregation procedures, formulae, and so on. They have been intended mainly to assist compilers of the relevant statistics in individual countries. This manual has the same principal objective.

The manual is also intended for the benefit of users of consumer price indices (CPIs), such as government and academic economists, financial experts and other informed users. The CPI is a key statistic for policy purposes. It attracts a great deal of attention from the media, governments and the public at large in most countries. Despite its apparent simplicity, the CPI is a sophisticated concept that draws upon a great deal of economic and statistical theory, and requires complex data manipulation. This manual is therefore also intended to promote greater understanding of the properties of CPIs.

In general, compilers and users of economic statistics must have a clear perception of what the statistics are supposed to measure, in principle. Measurement without theory is unacceptable in economics, as in other disciplines. The manual therefore contains a thorough, comprehensive and upto-date survey of the relevant economic and statistical theory. This makes the manual completely self-contained on both the theory and practice of CPI measurement.

The resulting manual is large. As different readers may have different interests and priorities, it is not possible to devise a sequence of chapters that suits everyone. Indeed, because this manual is intended to serve as a reference source, it will not necessarily be read from cover to cover. Many readers may be interested in only a selection of chapters. The purpose of this reader’s guide is to provide a map of the contents of the manual that will assist readers with different interests and priorities.

An overview of the sequence of chapters

Chapter 1 is a general introduction to CPI methodology, and is intended for all readers. It provides the basic information needed to understand the subsequent chapters. It summarizes index number theory, as explained in detail in Chapters 15 to 23, and outlines the main steps involved in the actual compilation of a CPI, drawing on material in Chapters 3 to 9. It does not provide a summary of the manual as whole, as it does not cover some specific topics and special cases that are not of general relevance.

Chapter 2 explains how CPIs have evolved in response to the demands made upon them and how the uses of CPIs affect the choice of methodology to be used. Chapter 3 is concerned with a number of basic concepts, principles and classifications, as well as with the scope or coverage of an index. The scope of a CPI can vary significantly from country to country.

Chapters 4 to 9 form an interrelated sequence describing the various steps involved in the compilation of a CPI from the collection and processing of the price data through to the calculation of the final index. Chapter 4 explains how the expenditure weights attached to the price changes for different goods and services are derived. These weights are typically based on household expenditure surveys supplemented by data from other sources.

Chapter 5 deals with sampling issues. A CPI is essentially an estimate based on a sample of prices. Chapter 5 considers sampling design, and the pros and cons of random versus purposive sampling. Chapter 6 is devoted to the procedures actually used to collect the prices from a selection of retail outlets or other suppliers. It deals with topics such as questionnaire design, the specification of the items selected, the use of scanner data and the use of hand-held computers.

Chapter 7 addresses the difficult question of how to adjust prices for changes over time in the quality of the goods or services selected. Changes in value resulting from changes in quality count as changes in quantity, not price. Disentangling the effects of quality change poses serious theoretical and practical problems for compilers. Chapter 8 covers the closely related question of how to deal with new goods or services not previously purchased and for which there are no prices in earlier periods.

Chapter 9 pulls together the material contained in the preceding five chapters and gives a step-by-step summary of the various stages of CPI calculation. It describes both the elementary price indices calculated from the raw prices collected for small groups of products and the subsequent averaging of the elementary indices to obtain indices at higher levels of aggregation up to the overall CPI itself.

Chapter 10 deals with a number of cases that require special treatment: for example, goods and services for which prices are not quoted separately, being embedded within composite transactions covering more than one item. It also examines the case of owner-occupied housing. Chapter 11 considers the errors and biases to which CPIs may be subject.

Chapter 12 deals with issues of organization and management. Conducting the price surveys and processing the results is a massive operation that requires careful planning and organization, and also efficient management. Chapter 13 is concerned with the publication or dissemination of the results.

Chapter 14 marks a break in the sequence of chapters, as it not concerned with the compilation of a CPI. Its purpose is different, namely to examine the place of the CPI in the general system of price statistics. The CPI should not be treated as an independent, isolated statistic. The flow of consumer goods and services to which it relates is itself only one of a set of interdependent flows within the economy as a whole. The analysis of inflation requires more than one index, and it is essential to know exactly how the CPI relates to the producer price index (PPI) and to other price indices, such as indices of export and import prices. The supply and use matrix of the System of National Acounts provides the appropriate conceptual framework within which to examine these interrelationships.

Chapters 15 to 18 provide a systematic and detailed exposition of the index number and economic theory underlying CPIs. Five different approaches to index number theory are examined that between them cover all aspects of index number theory. Collectively, they provide a comprehensive and up-to-date survey of index number theory, including recent methodological developments as reported in journals and conference proceedings.

Chapter 15 provides an introduction to index number theory focusing on the decomposition of value changes into their price and quantity components. Chapter 16 examines the axiomatic and stochastic approaches to CPIs. The axiomatic, or test, approach lists a number of properties that it is desirable for index numbers to possess and tests specific formulae to see whether or not they possess them.

Chapter 17 explains the economic approach based on the economic theory of consumer behaviour. On this approach, a CPI is defined as a cost of living index (COLI). Although COLIs cannot be calculated directly, a certain class of index numbers, known as superlative indices, can be expected to approximate COLIs in practice. An increasing number of economists and other users have concluded that, in principle, the preferred, ideal index for CPI purposes should be a superlative index, such as the Fisher index. This is reinforced by the fact that the Fisher also emerges as a very desirable index on axiomatic grounds.

Chapter 18 deals with aggregation issues. Chapter 19 uses a constructed data set to illustrate the numerical consequences of using different index number formulae. It demonstrates that, in general, the choice of index number formula can make a considerable difference, but that different superlative indices all tend to approximate each other.

Chapter 20 addresses the important question of what is the theoretically most appropriate form of elementary price index to calculate at the first stage of CPI compilation when no information is available on quantities or expenditures. This has been a comparatively neglected topic until recently, even though the choice of formula for an elementary index can have a significant impact on the overall CPI. The elementary indices are the basic building blocks from which CPIs are constructed.

Chapters 21 to 23 deal with difficult issues. Chapter 21 discusses adjusting for quality change, including the hedonic approach, from a theoretical viewpoint. Chapter 22 examines the treatment of seasonal products. Finally, Chapter 23 considers the treatment of durable goods. There is some tension in both national accounts and CPIs resulting from the fact that owner-occupied houses are treated as assets, whereas consumer durables are not. These treatments are not easy to reconcile conceptually and Chapter 23 discusses the theoretical issues involved.

The manual concludes with a glossary of terms, a bibliography, and four annexes on the following topics:

  • the Harmonized Indices of Consumer Prices (HICPs) of the European Union;

  • the Classification of Individual Consumption according to Purpose (COICOP), a household expenditure classification;

  • the resolution concerning consumer prices indices adopted by the Seventeenth International Conference of Labour Statisticians, 2003;

  • spatial comparisons of consumer prices, using purchasing power parities and the International Comparison Program.

Suggested reading plans

Different readers may have different needs and priorities. Readers interested mainly in the compilation of CPIs may not wish to pursue all the finer points of the underlying economic and statistical theory. Conversely, readers interested more in the use of CPIs for analytic or policy purposes may not be so interested in reading about the technicalities of conducting and managing price surveys.

Not all readers will want to read the entire manual but all readers, whatever their preferences, will find it useful to read the first three chapters. Chapter 1 provides a general introduction to the whole subject by giving an overview of the CPI theory and practice that is presented in the manual. It covers the basic knowledge required for understanding subsequent chapters. Chapter 2 explains why CPIs are calculated and what they are used for. Chapter 3 examines a number of fundamental concepts and the scope of a CPI.

A reading plan for compilers

Chapters 4 to 13 are primarily for compilers. They follow a logical sequence that roughly matches the various stages of the actual compilation of a CPI, starting with the derivation of the expenditure weights and the collection of the price data, and finishing with the publication of the final index.

Chapter 14 is intended equally for compilers and users of CPIs. It places CPIs in perspective within the overall system of price indices.

The remaining chapters from 15 to 23 are mainly theoretical. Compilers may find it necessary to pursue certain theoretical topics in greater depth, in which case they have immediate access to the relevant material. It would be desirable for compilers to be acquainted with at least the basic index number theory set out in Chapter 15 and the numerical example developed in Chapter 19. The material in Chapter 20 on elementary price indices is also particularly important for compilers.

A reading plan for users

Although all readers will find Chapters 1 to 3 useful, the subsequent ten chapters are designed primarily for compilers. Two topics that have, however, aroused considerable interest among many users are the treatment of quality change and new products. These are discussed at some length in Chapters 7 and 8. Users may also find Chapter 9 particularly helpful as it provides a concise description of the various stages of compiling a CPI.

Chapter 11 on errors and bias, and Chapter 14 on the system of price statistics are also of equal interest to users and compilers.

Chapters 15 to 23 covering the underlying economic and statistical theory are likely to be of interest to many users, especially professional economists and students of economics.

References

In the past, international manuals on economic statistics have not usually provided references to the associated literature. It was not considered helpful to cite references when the literature was mostly confined to printed volumes, including academic journals or proceedings of conferences, located only in university or major libraries. Compilers working in many statistical offices were unlikely to have ready access to such literature. This situation has been completely transformed by the Internet and the Web, which make all such literature readily accessible. Accordingly, this manual breaks with past tradition by including a comprehensive bibliography on the very large literature that exists on index number theory and practice.

1

The 2003 resolution concerning consumer price indices is reproduced in Annex 3. It can also be found on the ILO Bureau of Statistics web site: www.ilo.org/public/english/bureau/stat.

*

These members served for only part of the period.

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