Perceived inflation

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Even controlling for demographics, respondents with higher perceived inflation also tend to expect higher inflation, suggesting that changes in inflation perceptions could lead to changes in inflation expectations as well. The questions were posed in February, May, and August of this year and will be repeated in November. In this note, we focus on the responses from the February and May surveys but we plan on updating the analysis when we have the responses from all four surveys.

The two new questions:. Past one-year perception : During the past 12 months, do you think that prices in general went up or went down, or stayed where they were a year ago? Past five-to-ten-years perception : What about prices over the past 5 to 10 years?

Perceived and measured inflation after the launch of the euro: explaining the gap in Italy

Do you think prices now are higher, about the same, or lower than they were 5 to 10 years ago? One-year ahead expectation : During the next 12 months, do you think that prices in general will go up, or go down, or stay where they are now? Five-to-ten-years ahead expectation : What about the outlook for prices over the next 5 to 10 years? Do you think that prices will be higher, about the same, or lower, 5 to 10 years from now?

Figure 1 shows the distributions of the answers and Table 1 contains summary statistics. We show data for the February responses only; the results from the May and August surveys are broadly similar. Accessible version. As the histograms make clear, for each of the four distributions, the bulk of responses are in the range of 0 to 5 percent.

Thus, the responses for inflation perceptions appear broadly similar to those for inflation expectations.

What is Inflation?

That said, the distribution of perceptions is somewhat wider than for expectations, with a substantial minority of respondents perceiving inflation to have been materially outside a 0 to 5 percent range. The central tendencies of the responses for both inflation perceptions and expectations are somewhat higher than the published inflation data Table 1.

This is especially true for the means, as the distributions are slightly skewed to the right; trimming just a few outliers brings the mean, especially for perceptions, down toward the median. For readers who are concerned by even the modest differences between perceived inflation and the published inflation data, we ask you to reflect upon the difficulty of the problem posed to survey respondents.

Although some respondents might be familiar with recent published inflation data and base their responses on that knowledge, we surmise that the large majority instead base their responses on their own experiences. Some items are purchased infrequently; some items will have changed over time so that a direct price comparison is complicated or not meaningful; and pricing of some items like cell phone service plans may be quite complex.

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Even for individuals who pay close attention to the prices they face, performing a rough mental aggregation of all those different price movements is challenging. The trimmed mean, 10th, and 90th percentile are authors' calculations, in which we try to replicate the survey procedures for imputing missing data, adjusting for extreme values, and interpolating between integers. Asymmetry 90,10 is defined as 90th percentile - median - median - 10th percentile. The trimmed mean is obtained by omitting the largest 2 percent and the smallest 2 percent of the unweighted observations.

Return to text. Return to table. Furthermore, the finding that inflation perceptions tend to be above inflation as measured by the official price indexes may not be surprising for a number of reasons. First, consumers tend to recall price increases more readily than price decreases.

Interestingly, some other attempts to measure inflation perceptions have yielded perceptions that exceed the official inflation statistics by much more than the responses shown here. For recent U.

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Estimates for several European countries are similarly high see Biau et al. The demographics of long-term inflation perceptions and expectations Previous researchers have noted that inflation expectations tend to differ systematically for different groups of respondents, varying by gender, age, race, and income. Consistent with previous studies, we find that women tend to both perceive and expect higher inflation than men, with the difference being fairly sizable for perceived inflation. We also find that inflation perceptions and expectations tend to decline with income, and while inflation expectations are slightly lower for respondents less than 45 years old, perceived inflation is quite similar for the three age groups we consider.

In interpreting these results for different groups of respondents, one must remember that individuals with different consumption profiles, or shopping in different locations, will likely have different experiences with inflation. Thus, differing inflation perceptions could reflect those different experiences, rather than different perceptions of similar experiences. The trimmed mean is obtained by omitting the largest 2 percent and the smallest 2 percent of unweighted observations. The histograms in figures 2 show that most respondents expect either no change or a very small change in the rate of inflation compared to their perceptions of recent history.

The difference between individuals' expected and perceived inflation rates are distributed fairly tightly, and roughly symmetrically, around zero, with more than one-third of respondents expecting zero change in both the short- and the long-term inflation. The purpose of this paper is to give the reader an understanding of Brachingers new developed theory of perceived inflation. Additionally, Brachingers new developed Index of Perceived Inflation is introduced analyzed and critically reviewed.

Therefore the term paper is structured as followed:. To understand the basic underlying of Brachingers theory, it is necessary to refer to the Prospect Theory, developed by Kahneman and Tversky in The main focus from Prospect theory is laid on its assumptions. In detail, the first section starts with a brief thought experiment. Afterwards the concept of reference dependency and loss aversion will be introduced. The second part of this paper deals with Brachingers work on the theory as well as on the Index of Perceived Inflation.

It is shown how Brachinger derived his index from the general Laspeyres formula by adjusting for several restrictions from the Prospect theory. This chapter closes by presenting Brachingers results of perceived inflation for Germany in comparison to the actual rate of inflation after the currency changeover. The last part of this work deals with the criticism on Brachingers new developed theory. In particular, it is shown that Brachingers assumptions and simplifications are inappropriate to fully explain the phenomenon of perceived inflation.

Moreover, it is illustrated that Brachingers results are inconsistent with empirical results. Finally, the paper ends up with alternative explanations which are probably capable to explain the inflation as perceived. Lastly, a conclusion is drawn which will sum up the results and the ability whether perceived inflation is revealed or not.

Expected Utility Theory, Prospect Theory is a descriptive theory of human behavior towards risk.


Based on a compelling body of experimental research, Kahneman and Tversky suggested that people do not make decisions the way expected value theory predicts. Therefore it is essential to clarify the basic assumptions and the underlying philosophy of Prospect Theory in order to understand the idea and criticism on Brachingers Index of Perceived Inflation IPI. Thus, it is necessary to give the reader an understanding of Prospect Theory by starting with a small thought experiment.

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Which option would you choose? Certainly you would have chosen the sure gain.

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Once again, if you would have decided like the majority of the test persons you would not have chosen the sure loss. However, these results are contrary to classic economic theory, which expressly states that the behavior towards risk should only depend on the proportion of wealth of an agent to the value of opportunities for gains or losses.

Unlike classic economic theory, Prospect Theory claims that the outcome of a risky game is depending on a specific reference point of an agent.

Consequently, the outcome is coded as a gain or loss while the utility functions diverge in the scopes of gains and losses. As a result, this issue was met with severe criticism. Contrary to these critics one could say that the location of the reference point is in most cases, with sufficient certainty, apparent. Mainly, the reference point goes hand in hand with the actual state, the status quo.

A further important aspect to reference points is that people also code gains or losses according to their aspiration level. Everything which is below that reference point will be coded as a loss whereas additional profit will be coded as a gain. In short, people tend to avoid risks in the scope of gains and tend to seek risks in the scope of losses.

Thus, Prospect Theory proposes an S-shaped value function to illustrate the behavior towards risk. It is noteworthy that the shape of the function is a concave in the scope of gains and convex in the scope of losses. The flexion of the curve illustrates the psychophysical principle that people perceive the difference between 0 and larger as the difference between and Hence, a representative value function can be written as:.

One additional aspect of the value function is that slope of the function is larger in the scope of losses than in the scope of gains.

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Formula 1 clearly states that the value of a loss -x is perceived more strongly 2. This attribute is usually referred to as loss aversion. European Commission The euro, two years later, Flash Eurobarometer, Fluch, M. Gaiotti, E. Golinelli, R. Guiso, L. Hoffmann, J. An assessment of Professor H. Anni —, February, www. Kahneman, D. Kurri, S. What do they tell us?