The Measurement of Inflation: A Stochastic Approach

Abstract

The stochastic approach to index number theory views each commodity price change as an independent observation on the underlying rate of inflation so that inflation can be estimated by averaging over all the prices. This article extends the approach by (a) allowing for sustained changes in relative prices, (b) showing the link with Divisia index numbers, and (c) deriving standard errors for the inflation estimates. The results are illustrated with Australian data.