Working Paper: CEPR ID: DP16866
Authors: Xavier Jaravel; Danial Lashkari
Abstract: How should we measure changes in consumer welfare given observed data on prices and expenditures? This paper proposes a nonparametric approach that holds under arbitrary preferences that may depend on observable consumer characteristics, e.g., when expenditure shares vary with income. Using total expenditures under a constant set of prices as our money metric for real consumption (welfare), we derive a principled measure of real consumptiongrowth featuring a correction term relative to conventional measures. We show that the correction can be nonparametrically estimated with an algorithm leveraging the observed, cross-sectional relationship between household-level price indices and household characteristics such as income. We demonstrate the accuracy of our algorithm in simulations. Applying our approach to data from the United States, we find that the magnitude of the correction can be large due to the combination of fast growth and lower inflation for income-elastic products. Setting reference prices in 2019, we find that (i) the uncorrected measure underestimates average real consumption per household in 1955 by 11.5%, and (ii) the correction reduces theannual growth rate from 1955 to 2019 by 18 basis points, which is larger than the well-known “expenditure switching bias” over the same time horizon.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| traditional measures of consumer welfare underestimate average real consumption per household in 1955 due to ignoring the correction for nonhomotheticity (D11) | average real consumption per household in 1955 (D10) |
| the uncorrected measure fails to account for the differential inflation rates experienced by different income groups (E25) | systematic bias (D91) |
| applying their correction (C20) | annual growth rate of real consumption from 1955 to 2019 (E20) |
| the nonparametric correction (C14) | mapping between nominal and real consumption (D12) |
| the relative prices of income-elastic goods fall (D11) | curvature of the mapping between nominal and real consumption (D11) |
| the approach provides a more accurate measure of real consumption growth (E20) | measure of real consumption growth compared to conventional methods (E20) |
| their approach could inform the indexation of the poverty line and the targeting of welfare benefits (I32) | indexation of the poverty line and the targeting of welfare benefits (I32) |