Giorgia researcher from the greater Genoa area asks the following question:
Q. You say that current tools to estimate inflation lead to overestimating inflation and that it is necessary to consider qualitative changes. How do we measure qualitative changes? We co not have adequate tools for both qualitative and qualitative estimates? Do we have to give up measuring inflation? What constructive proposal can you make?
A. Thanks Giorgia for your question. The simplest answer is the following. We can divide products into two categories, high complexity products, and low complexity products. We can estimate inflation as usual on low complexity products, because we assume they will remain stable, and we stipulate that inflation is zero on high complexity products, because we assume that high complexity products exhibit high innovation.
The separation of high and low complexity products can be achieved using the Product Complexity Indexes developed by Hidalgo and Hausmann
Q. Don't we have an aggregation problem with complexity indexes?
A. No, complexity indexes are pure numbers and can be aggregated
Q. But how do you write models?
A. Well, in order to write a model we have to make an additional conceptual step. As I explained in other posts, macroeconomic models are abstract models that include theoretical terms and variables. Therefore, we have to construct models assuming that nominal GDP is the product of three variables, a quantity favtor, a quality factor, and an inflation factor. Empirically, we can estimate these models using the previous strategy, dividing products into high and low complexity products.
Q. Thanks for your answer. I am not familiar with complexity indexes but I trust that they exist.
A. I will devote a post to complexity indexes