How to Measure Consumer Price Inflation

Former Faculty Fellow, RIETI

Emerging from deflation is one of top priority policy issues for Prime Minister Shinzo Abe's administration. The government and the Bank of Japan (BOJ) are now conducting an extraordinary experiment to increase the rate of consumer price inflation, which is currently at almost 0%, to 2% within two years.

An accurate understanding of the current state of prices is the first step in overcoming deflation

The first step in overcoming deflation is to understand correctly the present state of consumer prices. Prices in Japan are measured by the Statistics Bureau of the Ministry of Internal Affairs and Communications. The consumer price index (CPI) compiled by the bureau is the most-watched index by the BOJ. The index also plays an important role in determining a sliding scale for pension payouts, directly affecting peoples' lives.

However, it is not an easy task to measure consumer prices. If the prices of all products uniformly rise by 2%, then the inflation rate is 2%. But it is not actually that simple. The prices of some products increase, while others fall. In that case, what does prices "as a whole" rising by 2% mean? It is very difficult to determine a calculation method that makes sense to everyone. The Japanese CPI is calculated based on the criteria set by the International Labor Organization (ILO), etc. and meets international standards. Nevertheless, it is not the best and only index. Indeed, there is room for improvement in many aspects.

Consumers want to buy products as cheaply as possible. This trend is particularly noticeable in Japan, which has been in a prolonged economic slump. However, it is very difficult to trace correctly such consumer behavior. With the number of price investigators at the Statistics Bureau limited due to severe budget restrictions, monitoring the consumption behavior of all consumers is unfeasible. Checking the prices of the predetermined items at the predetermined stores is the maximum they can do.

So, is there a solution to this? If it were 10 years ago, there would be none. But it is different now. There is a cost-effective way to compile a superior quality CPI.

Some European countries, such as Switzerland and the Netherlands, are attempting to compile CPIs using scanner data, which are accumulated when merchandise barcodes are scanned at supermarkets' cash registers. These countries are compiling their CPIs using the scanner data obtained from retailers. Scanner data clearly show that consumers rush to buy products as cheaply as possible. By utilizing these data, good-selling products can be correctly identified, and an accurate CPI can be measured. Scanner data are "big data" on consumer prices.

I have conducted research on evaluating measuring errors in consumer prices using a set of scanner data in Japan. As such, the discussion paper "How Fast Are Prices in Japan Falling?" (12-E-075) was written to discuss the results of RIETI's research project called "Long-term Deflation in Japan: Its causes and policy implications."

The most distinctive feature of this dataset is the tracking of daily purchasing records over a quarter of a century, from 1988 to 2013. Although there are a number of scanner data around the world, there is no other dataset that covers such a long period of time.

The UTokyo Daily Price Index enables monitoring of prices on a real time basis

The University of Tokyo started its pricing project on May 24, 2013 and has released the University of Tokyo Daily Price Index (UTokyo Daily Price Index, available only in Japanese), which takes maximum advantage of scanner data. Detailed daily information on prices and sales volume are sent from about 300 supermarkets nationwide after business hours. The data cover all products handled by supermarkets (including food and daily goods), with the number of categories exceeding 200,000, and are processed to compile the index, which is published on its website. Even if delays in data transmission from stores and other factors are taken into account, the prices reported three days prior can be known. The current official CPI is published once a month, and the index for the respective month is released at the end of the following month. Compared to this, the UTokyo Daily Price Index enables us to know the state of prices far earlier. This is a step toward monitoring consumer prices on a real time basis, just like share prices and foreign exchange rates.

The UTokyo Daily Price Index is a new attempt in that a university is compiling price-related statistics. Given that economic and statistical theories are indispensable in measuring consumer prices, however, it is no big surprise that a university is doing this. In fact, since 2010, macroeconomic researchers at the Massachusetts Institute of Technology (MIT) have collected prices from the Internet and compiled a daily price index using the data. The index has been widely used by financial institutions and institutional investors to help forecast future consumer prices. A similar project is being carried out by a non-academic entity. Google Inc. is compiling a daily price index covering the whole world by collecting prices from the Internet using its search function. The common practice of price indexes being compiled solely by government agencies has become a thing of the past.

If consumer prices are the "temperature" of the economy, then price indexes are the "thermometer." To maintain socio-economic soundness and ensure its stable operations, an index with little error margin is indispensable. Particularly in present-day Japan, where the inflation rate is at around 0%, it is hard to tell whether the country is in inflation or deflation. Although an expensive thermometer is not necessary to measure the high temperature resulting from influenza infection, to detect a slight temperature, a high precision thermometer is needed. It is crucial for Japan to have a highly accurate price index. In order to overcome deflation, it is hoped that the UTokyo Daily Price Index will be utilized as the second thermometer of the Japanese economy.

May 23, 2013

June 17, 2013