Does the CPI mirror costs-of-living? Engel's law suggests not in Norway
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Date
2004Metadata
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- Discussion Papers [1002]
Abstract
There is considerable interest in identifying the magnitude of the difference between increases in CPI
and costs-of-living, and this article uses the technique proposed by Hamilton (2001) to measure this
discrepancy for Norway for the 90s. The method is extended along several dimensions by
introducing a framework in which measurement errors are modelled. A non-parametric approach is
then employed to segment households into demographic types while allowing for flexibility in costsof-
living increases for different standards. Hamilton finds that American CPI overstates costs-of-living
in the U.S. for the period 1974-1991, Norwegian results for 1990-1999 indicate that CPI sometimes
may understate costs-of-living, perhaps because of a credit-financed boom in house prices. The
Norwegian CPI rose 22 percent in the period, but the general consumer behaved as if costs-of-living
increased more than 35 percent. For some segments of society, for example single-person
households, the increase was substantially larger, suggesting potentially important distributional
effects.
Keywords: Almost-Ideal-Demand-System, consumer price index bias, cost-of-living, demand for
food, Engel's Law, household behavior, house prices, inflation, real income, standards of living