Measuring the Dynamic Cost of Living Index from Consumption Data

Abstract

In the U.S., the objective of consumer price index (CPI) measurement is to measure the cost of living. However, the current CPI or, in other words, cost of living index (COLI) measures the cost of living in a static optimization problem. This paper proposes a new method to construct a dynamic cost of living index (DCOLI). Our method offers several advantages compared to other dynamic cost of living indices proposed in the literature. First, our measure is based on total wealth. Previous indices limited attention to financial wealth. Second, we consider an Epstein-Zin preference structure. Most previous literature has used log preferences. We derive formulas that relate our DCOLI to the COLI and derive conditions under which the two coincide. We also produce empirical measures of our DCOLI. We find that under standard assumptions on preferences, the volatility of our DCOLI is about the same as that of the COLI. In certain periods, e.g., 1977–1983, our measure differs sharply from the COLI.dynamic cost of living index; cost of life; CPI