As an application of the hedonic approach, this paper provides empirical evidence showing why the Japanese CPI has failed to account for quality changes in automobiles. The paper find first that, between 1990-94, quality-adjusted price index for automobiles declined 0.3% annually, while the automobile CPI rose 0.6% ; this decline in the quality-adjusted price index reduced the durable goods CPI by 0.2% per year, and the overall CPI by 0.01%. Second, quality-adjusted price indexes for automobiles vary from size to size and from styling to styling, which implies limited coverage and sampling for the automobile CPI may affect the accuracy of the official CPI. Third, the current methodology used in the CPI to cope with quality adjustment in specification changes has failed to account for quality changes between existing and new automobiles; while the hedonic approach has proved to be an effective way to increase the accuracy of quality adjustment.
Keywords: Hedonic Price Index; Quality Changes; Measurement Errors; Automobiles; Multicollinearity; Principal Components.
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.