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Changing Tastes Versus Specification Error in Cost-of-Living Measurement

Robert Martin


Several recent papers aim to account for changing preferences in cost-of-living indexes (COLI). Workhorse models like Constant Elasticity of Substitution (CES) attribute the errors in demand regressions entirely to preferences, leaving no room for other sources of error.  Using a Monte Carlo experiment and retail scanner data, I find evidence that model misspecification can lead to misleading conclusions about the degree of taste change reflected in CES-based price indexes. Nevertheless, under misspecification, a Sato-Vartia index still approximates a conditional COLI that fixes tastes to an intermediate level.