Most countries measure inflation by simply looking at changes in the prices of individual goods. However, some countries, such as the US, also take into account changes in the quality of goods in a process known as hedonic price adjustment. It is usually applied to hi-tech products such as computers and mobile phones.
For example, a £1,000 computer you buy today might be twice as powerful as one you could have bought for the same price a year ago. To capture this change in quality, US statisticians ask what it would have cost to buy one of the same power back then (let’s say it would have cost £2,000 last year). This makes it look as if the price of the computer has halved, which has the knock-on effect of making the rate of inflation look lower than it actually is. And because GDP is adjusted for inflation, it affects those figures too and massages them upwards.
If everyone used hedonic adjustment, it wouldn’t be a problem, as we are mainly interested in relative changes and performance. However, while it has been used in the US national accounts since 1987, the technique isn’t used in Germany, for example, so any comparison between these two countries that relies on this number is flawed.
• See Tim Bennett’s video tutorial: Beginner’s guide to investing: how to beat inflation.