Spending habits are mitigated by inflation though. For example, I buy significantly less beef than I did five years ago because it is now too expensive. Putting less weight on beef prices because of the reduction in consumption would indicate that inflation is less than it actually is.
> For example, I buy significantly less beef than I did five years ago because it is now too expensive. Putting less weight on beef prices because of the reduction in consumption would indicate that inflation is less than it actually is.
If people spend on item X less or no more, why would it be included in the index at the old weight? For any given period of time being measured, the basket of goods and their weights should reflect what people are actually doing. Why would you run a model that samples the wrong things?
This is one reason why (e.g.) StatCan went from updating their basket every 2-3 years, to annually in the last little while: spending habits shifted drastically in over the course of the pandemic.
Substitution is a known source of (possible) error and there are attempts to take it into account:
> 9.22 The other potential source of error with respect to the basket weights is referred to as upper-level substitution bias. This bias arises because of the use of the Lowe formula, which is an asymmetrically weighted fixed-basket price index. Because the weights are obtained from a year that precedes the price reference period, the expenditures are not likely to be fully representative of consumer spending patterns in the price observation periods. This is because consumers tend to adjust their spending habits in response to changes in relative prices, buying more of the products whose prices have fallen or risen less rapidly, while reducing their purchases of products whose prices have increased the most. In other words, they substitute towards relatively cheaper products from relatively more expensive ones. The asymmetrically weighted fixed-basket formula of the CPI does not account for these types of changes in consumer spending until a basket update is performed.
> 9.23 Unlike the Lowe formula, there are five known symmetrically weighted price index formulaeNote which are theoretically free from upper level substitution bias. These index formulae use expenditures from both the price reference period 0 and the price observation period t and therefore account for product substitutions that consumers may make. In this regard they are representative of consumer spending for the periods in which price change is being calculated.
> If people spend on item X less or no more, why would it be included in the index at the old weight?
Say ten years ago, hypothetically, everyone ate steak and wine every day for $100/week and today everyone can only afford to survive on ramen and tap water and it costs $100/week.
If you change the basket to say people today only want ramen, you will conclude that there has been 0% inflation in a decade. Everyone still spends $100/week on food, no change at all!
