Statements to Congress - Statements by Alan Greenspan to the Senate Committee on the Budget and the Senate Committee on Finance

Federal Reserve Bulletin, March, 1997

In judging these evaluations, it is incumbent upon us to resist the evident strong inclination to believe that precision is the equivalent of accuracy in price bias estimation. If we cannot find a precise estimate for a certain bias, we should not implicitly choose zero as though that were a more scientifically supportable estimate.

There is no sharp dividing line between a pristine estimate of a price and one that is not. All of the estimates in the CPI are approximations, in some cases very rough approximations. Further, even very rough approximations can give us a far better judgment of the cost of living than holding to a false precision of accuracy. We would be far better served following the wise admonition of John Maynard Keynes that "it is better to be roughly right than precisely wrong."

Estimates of the magnitude of the bias in our price measures are available from a number of sources. Most have been developed from detailed examinations of the microstatistical evidence. However, recent work by staff economists at the Federal Reserve Board has added strong corroborating evidence of price mismeasurement using a macroeconomic approach that is essentially independent of the exercises performed by other researchers, including those on the Boskin Commission. In particular, employing the statistical system from which the Commerce Department estimates the national income and product accounts, the research finds that measured real output and productivity in the service sector are implausibly weak, given that the return to owners of businesses in that sector apparently has been well maintained. Taken at face value, the published data indicate that the level of output per hour in a number of service-producing industries has been falling for more than two decades. In other words, the data imply that firms in these industries have been becoming less and less efficient for more than twenty years.

These circumstances simply are not credible. On the reasonable assumption that nominal output and hours worked and paid of the various industries are accurately measured, faulty price statistics are almost surely the likely cause of the implausible productivity trends. The source of a very large segment of these prices is the CPI.

For this exercise, the study used the gross domestic product chain-weighted price measures. Although these price measures are based on many of the same individual price indexes included in the CPI, they do not suffer from upper-level substitution bias. Hence, the price mismeasurement revealed by this data system largely reflects shortcomings in quality adjustment and in the treatment of new goods and services. If, instead of declining, productivity in these selected service industries was flat, to up a modest 1 percentage point per year, the implicit aggregate price bias associated with these service industries alone would be about 1/2 percentage point or so per annum in recent years--very similar in magnitude to the Boskin Commission estimate of total quality adjustment and new products bias.