"the hedonic method"

I'm reading Karl Whelan's A Guide to the Use of Chain Aggregated NIPA Data PDF. Menzie Chinn linked to it, and Justin Fox, regarding errors in the use of "chain-weighted" inflation-adjusted data.

I need some background on "hedonics":

Source: OECD

Source: Abstract, The Hedonic Method by Laura O. Taylor at Springer Link

In economics, hedonic regression or hedonic demand theory is a revealed preference method of estimating demand or value. It breaks down the item being researched into its constituent characteristics, and obtains estimates of the contributory value of each characteristic....
Hedonic models are commonly used in real estate appraisal, real estate economics, and consumer price index (CPI) calculations. In CPI calculations, hedonic regression is used to control the effect of changes in product quality. Price changes that are due to substitution effects are subject to hedonic quality adjustments.

Source: Wikipedia, Hedonic regression

Whelan describes the problem with the old "fixed-weight" method, the problem which led to the adoption of the "chain-weight" method:

... for a given base year, the growth rate of a fixed-weight quantity index tends to increase over time as the output bundle becomes increasingly expensive when measured in terms of the base year's prices. This problem became more severe after the mid-1980s because of BEA's decision to measure computer prices according to the hedonic method pioneered by Zvi Griliches (1961). This approach revealed enormous declines in the quality-adjusted price of computing power and the introduction of these prices accentuated the tendency of fixed-weight GDP to accelerate over time.

"The quality-adjusted price of computing power". That's the "hedonics" thing.

OECD describes quality adjustment:

The process - or the result of the process - of estimating what the market price of a replacement product would be if it had the characteristics of the product it replaces and with whose price its price is to be compared.

BLS explains it less objectively:

The CPI is calculated using prices for a fixed basket of goods and services through time. While the basket is periodically revised to reflect changing consumer expenditures, some items being priced in the sample come and go from the marketplace, making collection of these prices from month to month difficult. When an item is no longer available in the marketplace, a similar replacement item is selected. Often there are no similar items from which to choose, and as a result, a less comparable item is selected, potentially introducing quality change and an associated price differential into the index. The hedonic quality adjustment method removes any price differential attributed to a change in quality by adding or subtracting the estimated value of that change from the price of the old item.

consumerpriceillusion has a different take:

Ostensibly, the CPI is a linear combination of the “prices” of things/stuff consumers could actually purchase weighted by a percentage that the “ideal consumer” spends on any particular stuff/thing in his “ideal” basket. The main problem here is that the “prices” used are not the prices a consumer would actually pay; instead the real price for an item is scaled by what the BLS calls a “Hedonic Quality Adjustment (HQA)”. The HQA was designed to solve a real world problem economists face: the market keeps pumping out new and better devices. In practice the HQA is used to artificially depress the prices used in the calculation of the CPI.

For me... Well, let me tell you about my experience with computers. When I bought my first modem it cost me $150. It was a 300 baud modem. Several years later I bought a 56K modem. It cost me $150. For me, $150 was an acceptable price for a modem.

My first hard drive cost me $400. It was a 40-meg drive. Several years later I bought another hard drive: 400 gig. It cost me $400. For me, $400 was an acceptable price for a hard drive.

In my experience, the price of modems and hard drives didn't go up at all. But if you used hedonics to "adjust" those prices for quality, the prices would have fallen. A lot.

But the prices didn't fall. The technology got better, but the prices didn't fall.

"In practice the HQA is used to artificially depress the prices used in the calculation of the CPI."

Yup.


Oh. The reason this comes up. There is a lot of noise these days about low productivity, and how productivity "really" isn't low. It's just not counted right, they say. Or it's not countable. Or some other story. It's all noise.

It is noise that will eventually lead to a revision in the way productivity is calculated. A revision that makes productivity look better than it is today. A bullshit revision, another one, like not counting people who are unemployed and like using hedonic adjustment to "reduce" inflation.

I object.