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Economics
- ISSN: 2155-7950
- Journal of Business and Economics
How Chained CPI Underestimates Inflation: Chained CPI, Transition Costs and Behavioral Economics
David Axelro
(Montclair State University, USA)
Abstract: Some economists contend that accounting for substitution bias improves Chained-CPI’s estimate of inflation. This paper considers that the cost to change behavior increases the total cost of a new market basket, thereby leading to Chained-CPI underestimating inflation. This contradicts the premise of substitution along a fixed indifference curve. We use the concept of an exclusionary zone to explain why people might not change behavior, and how the utility derived from change is less than expected. It is concluded that the fixed-basket approach is the more accurate inflation estimate, while differences between CPI and COLA can be clearly stated
so that people can better optimize consumption.
Key words: chained CPI; exclusionary zones; transition costs; behavioral economics; change-adjusted utility
JEL codes: E31, E70, D90
