Fix the Faulty CPI

By C.D. Howe Institute —— Bio and Archives March 8, 2011

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Toronto, March 8 – Fixing measurement errors in the Consumer Price Index is a small idea that offers big payoffs to Canadians and the government, according to an e-brief released today by the C.D. Howe Institute. In “Fixing Canada’s CPI: A Simple and Sensible Policy Change for Minister Flaherty,” economist Christopher Ragan, who is David Dodge Chair in Monetary Policy at the Institute, says if the upcoming federal budget devoted the resources needed to improve Statistics Canada’s measurement of the Consumer Price Index, Canadians would have a truer sense of changes in the cost of living, monetary policy would be guided by a more accurate measure of inflation, and Minister Flaherty would more easily achieve the government’s commitment to balance the federal budget by 2015/16.

Accurate measurement of the Consumer Price Index counts, says Professor Ragan. Consumers rely on the CPI as a barometer for their cost of living and purchasing power. Ottawa uses it to set the payouts of inflation-indexed programs and the thresholds of personal income-tax brackets. However, because it does not take account, for example, of consumers’ habits of switching away from goods with temporarily high relative prices, the measured CPI inflation rate is biased upward by about 0.6 percent on average. So when the measured inflation rate is at the Bank of Canada’s 2 percent target, the true rate of inflation is closer to 1.4 percent. Errors in measuring inflation cost the federal government, says Professor Ragan, hundreds of millions of dollars annually. Correcting them by improving survey conduct and design would help Minister Flaherty achieve a balanced budget and create a simple and transparent fiscal system that operates in its intended fashion, to Canadians’ benefit.