3. Officially measured inflation and perceived inflation

As we buy goods and services and observe their prices, we get a sense of how fast and how much these prices change. But quite often our perceptions do not match the official inflation figures. How can measured inflation remain low although prices for fresh vegetables are soaring and the media is reporting large increases in rents in big cities? The following sections try to explain inflation perceptions and why they differ from measured inflation.

 3.1 Why does perceived inflation differ from officially measured inflation?

Opinions about rising prices are as old as money itself. Today they are often documented in surveys, which report that people’s perceptions of inflation are frequently higher than measured inflation.

But why is this the case? Research has found the following possible answers to this question:

  • Price rises catch our attention more than stable or declining prices and stay in our memory for longer. Although we tend to take less notice of stable or declining prices, they too are included in the calculation of the average inflation rate.
  • We pay more attention to the prices we pay for frequent out-of-pocket purchases than to prices of infrequent purchases and to direct debits. When we think about inflation, we often have in mind the prices of goods and services that we buy most frequently, like petrol, bread or haircuts. If these prices have increased above average, we may overestimate the actual rate of inflation. Conversely, price changes of goods and services that we buy less often (like cars and furniture) or that we pay for by direct debits from our bank accounts (like monthly rents or insurance fees) may have a lower impact on our perceptions of the inflation rate.
  • Price developments are not all the same. The inflation rate is an average of changes in the prices of all the goods and services that households spend their money on. Developments in individual prices can be totally different with some prices rising, others falling and some remaining constant, as you can see in the chart entitled “Inflation rate”. So if you only notice prices that increase, and not those that decrease, your perception of inflation may differ from measured inflation.
  • Consumption habits have an impact on your “personal” inflation rate. The HICP is based on a basket of goods and services that reflects the expenditure of all the people in a given country or area (like the European Union or the euro area). While all of our expenditures are included in the basket, we each experience a different inflation rate. The more our individual spending pattern differs from the composition of the overall spending pattern, the more our personal inflation rate deviates from measured inflation. For example, if petrol prices increase much more than the prices of other goods and services, people who use a car frequently may feel that inflation is higher than the measured rate because their personal spending on petrol is higher than average. Other people may experience lower inflation than the measured inflation rate because the prices of products that they buy frequently rise less than average. Such differences in perceptions can be seen between different demographic groups in the population. See the chart entitled “Inflation perceptions by demographic groups” to discover these differences.
  • Inflation rates reflect changes in prices compared with their level in the previous year, but our memory goes back further. The HICP is usually reported as an annual (or “year-on-year”) growth rate. This means that the general price level at a particular point in time – for instance [Date 1] – is compared with the level at the same point in time one year earlier – in this case [Date 2]. However, when people compare price levels, they may think back to what price levels were several years ago. Over a long period of time prices tend to rise substantially, even if inflation remains low. For example, if prices rise by 2% every year, after ten years the general price level will have increased by over 20%.
  • Changes in measured prices can also result from changes in product quality or quantity. We often consider changes to a product’s price tag to be the only cause of inflation. But sometimes it is the quality or quantity of the product that changes. The HICP deals with this by adjusting for the change in quality or quantity. For example, if a chocolate bar costs the same in two consecutive months but its weight is reduced from 200g to just 150g in the second month, we all would agree that we get less for our money even though there is no change to the price tag. To take into account the change in the weight of the chocolate bar, statisticians make adjustments so that the index records a price increase. However, if we only look at the figure on the price tag, we will not notice this change.

Use the visuals to see the inflation rates for different products in the HICP basket.

Click to enlarge and interact

Click to enlarge and interact