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improvements in quality and changes in product mix. While this conceptu-
al problem applies to nearly all the quantity series, it undoubtedly is most
serious in the machinery branch. Similarly, disguised inflation that enters
the value series, usually under the guise of new-product pricing, leads to an
overstatement of growth. This occurs when enterprise managers make
minor modifications to an existing product to justify a price higher than
would be warranted by the marginal improvement. This problem is most
acute in the machinery branch, especially in producer durables where the
value series have a large weight and grow much faster than the physical
output series. On one hand, evidence suggests that the quantity series may
bias the growth rate for selected machinery products downward by as
much as 1 percentage point per year; the bias in quantity series for other
branches probably is smaller. On the other hand, indications exist that
disguised inflation in the value series in our machinery sample may display
growth trends that are biased upward by as much as 3 percentage points
per year. (The value series are not a significant problem in other branches
because of their infrequent use and small weight.)
As for the net effect of these biases, if all the difference in growth rates be-
tween the value and physical series in the producer durables sector, where
the problems of bias are the worst, were actually attributable to inflation,
the SPIOER index would overstate machinery growth by a maximum of
1.2 percentage points per year and overall industrial growth by 0.3
percentage point. But the machinery inflation bias is probably much less
because the quantity series, by understating growth, partially offset the
upward biases of the value series.
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Approved for Release: 2019/07/19 C05210421