EN Official Journal of the European Union C 27/129

Opinion of the European Economic and Social Committee on ‘The reasons for the difference between perceived inflation and actual inflation’

(2009/C 27/27)

On 17 January 2008 the European Economic and Social Committee, acting under Rule 29(2) of its Rules of Procedure, decided to draw up an own-initiative opinion on:

The reasons for the difference between perceived inflation and actual inflation.

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 3 June 2008. The rapporteur was Mr Derruine.

At its 446th plenary session, held on 9 and 10 July 2008 (meeting of 9 July), the European Economic and Social Committee adopted the following opinion by 125 votes in favour, with two abstentions.

1. Recommendations

1.1 As already recommended by the Committee, ‘Statistics on wages (and perhaps incomes) should be broken down into at least quintiles, in order to gauge the impact of wage policy on price stability more clearly’ (1). Paragraph 4.3.3 demonstrates the differences in consumption profiles according to income. Moreover, the marginal propensity to consume also varies, so it is important to be able to identify which income group benefits from which wage increase (in %). Without this information, monetary policy might react inappropriately to wage and salary increases.

1.1.1 In addition, following the example of the study carried out by the Belgian National Bank (2), the European Commission and/or the European Central Bank should publish figures at least once a year on the impact of inflation on household purchasing power by level of income.

1.1.2 Europe's islands should all have statistical services and a price index at local level to allow for objective measurement of the additional costs imposed by their island status. Their statistical services should develop a common evaluation methodology for this purpose.

1.2 Similarly, the Member States and Eurostat should be asked to make more use of the price data they collect in order to produce detailed indices breaking down price rises by category of distribution circuit and by category of products, ranking them according to whether they are bottom of the range, medium-range or top of the range. The fear is that bottom-of-the-range products, particularly foodstuffs, have experienced even larger price increases. An international comparison of the price data collected by the institutions responsible for calculating inflation could help to answer the questions raised in point 1.4. The EESC also wonders whether it might be useful to consider developing a price index for older people.

1.3 The Committee hopes that the work being done at Eurostat to develop rigorous methods for incorporating changes in housing costs into the inflation index will be completed quickly and will produce operational proposals to be presented to the economic and social partners involved. As a general point, the Committee would like to be involved in the methodological reviews of the HICP carried out by Eurostat.

1.4 The European Commission should examine the simultaneous trend in the indices of consumer prices, production prices and import prices, because it is surprising that the import prices of certain indicators have fallen sharply but this has not been felt by the final consumer. It would be unacceptable if consumers were allowing themselves to be overcharged because they lacked certain vital information. This would only rebound on the single currency, which would suffer a blow to its reputation which it could do nothing about.

1.5 Although it is aware of the difficulties Eurostat faces in collecting the data, the Committee wonders whether it would be possible to publish the data on private household consumption a little faster. It currently takes three years for the data to appear (so the figures for 2005 were not published until 2008!). Some data (particularly on income distribution) have not been updated since 2001. Also, in view of the pace of social change, it might be better to shorten the time between surveys (currently six years).

1.6 Finally, the EESC recommends supporting the public institutions and NGOs which provide information for consumers and help them to make choices that are becoming increasingly difficult as marketing techniques and service packages become more sophisticated.

2. Introduction

2.1 Since its launch (exchange rate parities fixed in 1999, introduction of euro notes and coins in 2002 for the first members of the EMU) the single currency has been the subject of every possible criticism: while the euro was initially mocked for its depreciation against the major world currencies, its rise in value over the last three years has prompted fears about the competitiveness of European businesses abroad. Some governments have also fuelled this criticism in order to distract attention from their own economic policy mistakes. A small minority have even blamed the single currency, at least partly, for the lack of genuine convergence between the countries of the euro area, leading to calls for their country to withdraw from the euro area.

2.2 The statistics on the harmonised index of consumer prices (HICP) show that inflation fell significantly during the third phase of the preparation for EMU and has remained at a historically low level ever since, probably because the fact that it is easier to compare prices has stimulated competition and curbed price rises. However, a large majority of Europeans blame the euro for the difficulties experienced by their national economy and believe that the changeover to the euro created inflationary pressures which have eroded their purchasing power. Moreover, some people would support a return to dual price displays, which would be a severe setback for the supporters of European integration. The result is a distrust of the euro and, more generally, of Economic and Monetary Union. So, whereas in September 2002 59 % of Europeans regarded the single currency as ‘advantageous overall’ compared to 29 % who were sceptical (Eurobarometer survey, 2006), four years later enthusiasm for one of Europe's most important political initiatives of the last 20 years had been severely eroded, with 81.4 % of the public believing that the euro had led to price rises.

2.3 Until the introduction of the euro, consumers' perception of inflation broadly corresponded to that of the HICP. Since 2002 this has no longer been the case, with the divergence being greatest in 2003 and subsiding slightly thereafter. Since 2006 the gap has widened again. Since the end of 2004 perceived inflation has stabilised around a level higher than that recorded in 2001.

2.4 In the majority of the countries that joined the EU in 2004 actual inflation increased at the time of accession — or even in 2003 — as a result of the increase in indirect taxation and administered prices, particularly in agriculture. It subsequently came down again in a number of countries, but perceived inflation increased more rapidly. The Czech Republic is the only country where perceived inflation is lower than actual inflation, according to data from early 2008.

2.5 If we take the case of Slovenia, which is the first of these countries to have adopted the single currency, we also find that perceived inflation rose sharply in 2007 with the introduction of euro notes and coins and that expectations of price rises during the two years preceding the changeover ‘prepared the way’ for this rise.

2.6 These doubts about the health of the euro are in contrast to the positive verdict of European and non-European countries alike: according to the IMF, the euro's share in international reserves increased from around 18 % in 1999 to around 25 % in 2004. This success is even more marked in the emerging economies. The fact that 37 % of all foreign exchange transactions worldwide and between 41 % and 63 % of imports/exports are denominated in euros is proof of its success.

2.7 The aim of this own-initiative opinion is to explain the inflation trend and the reasons behind the persistent gap between inflation as perceived by the general public and actual inflation and, where appropriate, to formulate recommendations.

3. Price trend in the euro area and the three countries that are not members

3.1 Many Europeans believe that the euro has caused prices to rise. However, if this were the case, there would be differences between inflation in the countries of the euro area and inflation elsewhere. Yet the price trend in the euro area was similar to that in the three countries which did not have the single currency at the time (Denmark, Sweden and the United Kingdom).

3.1.1 The correlation matrix shows the extent of the similarity between price movements in the euro area and the three other countries, on the one hand, and between price movements in each of these countries, on the other. The figures in each cell vary between 0 (no correlation) and 1 (perfect correlation). Correlation matrix, 2000-2002 Euro area Denmark Sweden United Kingdom Euro area 1.00 0.52 0.67 0.67 Denmark 1.00 0.35 0.47 Sweden 1.00 0.47 United Kingdom 1.00 Correlation matrix, 2002-2004 Euro area Denmark Sweden United Kingdom Euro area 1.00 0.29 0.78 0.80 Denmark 1.00 0.34 0.40 Sweden 1.00 0.75 United Kingdom 1.00 Source: Eurostat; own calculations.

3.1.2 The correlation between inflation in the euro area and in the United Kingdom and Sweden increased following the introduction of the euro. The opposite was true in the case of Denmark. However, the correlation between Danish and UK prices declines and the correlation with Swedish prices remains stable but weaker.

3.1.3 It is also striking that, with the exception of the pair Denmark-UK, the correlation between these three non-euro countries is stronger with the euro area than among themselves.

3.2 This shows that the price movements within the euro area cannot be attributed to the euro, because they have been similar to those in the countries which did not adopt the single currency.

3.3 The table below shows the 12 main categories of goods and services (individual consumption of households by purpose) which are used to calculate the HICP, their respective weighting and the rate of price increase in the two years preceding and following the introduction of the euro. The conclusion at this level is that only three of the categories show a marked acceleration in prices: alcoholic drinks and tobacco (for which the price rise can be explained by higher excise duties), health and transport. At the same time, it is true that a more detailed breakdown of the figures reveals a price acceleration in certain areas (e.g. rental price inflation increased from + 1.5 % between 2000 and 2002 to 2 % between 2002 and 2004). Euro area 2000-2002 2002-2004 Price acceleration Average weighting 2000-2004 cp00 All items HICP 2.31 1.99 cp01 Food and non-alcoholic beverages 4.47 1.50 157.91 cp02 Alcoholic beverages, tobacco and narcotics 3.11 5.42 39.71 cp03 Clothing and footwear 0.64 – 0.09 75.87 cp04 Housing, water, electricity, gas and other fuels 2.81 2.19 154.96 cp05 Furnishings, household equipment and routine household maintenance 1.68 1.12 79.84 cp06 Health 1.59 4.93 36.04 cp07 Transport 1.49 2.51 153.67 cp08 Communications – 5.07 – 0.73 28.23 cp09 Recreation and culture 1.22 0.10 98.10 cp10 Education 3.46 3.49 9.21 cp11 Hotels, cafés and restaurants 3.69 3.23 91.25 cp12 Other goods and services 2.86 2.53 75.25 Source: Eurostat; own calculations.

4. Reasons for the difference between perceived and recorded inflation

4.1 Socioeconomic explanations

4.1.1 The introduction of the euro came just months after 11 September, at a time of profound global (and economic) insecurity. This was exacerbated by the economic downturn, which was in stark contrast to the high growth years 1999 and 2000.

4.1.2 One explanation for the persistent gap between perceived and actual inflation lies in a combination of factors: the frequency of purchases of the various goods and services which feature in the calculation of the HICP; the change in their respective prices; the importance attributed to them by consumers.

4.1.2.1 The following table tries to objectivise these factors by grouping all of the HICP indicators into five ‘families’: goods and services which are bought on a regular basis (at least once a month), those which are bought less frequently and those where the frequency of purchase can vary according to the individual and the circumstances. In the case of the first two categories a distinction is also made according to whether or not the goods or services in question are subject to strong national or international competition.

4.1.2.2 It is clear from the table that, overall, the prices of indicators which are subject to weak competition have increased much faster than average inflation in the period 2000-2007 (+ 2.12 %). The table also confirms that the prices of goods bought less frequently and subject to strong competition have done a great deal to limit inflation (+ 0.37 %), because they account for a large share of inflation (with a weight of 27 %, second only to ‘regular purchases/weak competition’ category with 34 %). Categories of indicators Degree of competition Annual % increase 2000-2007 Contribution to HICP Weight in HICP Regular purchases weak 2.34 0.92 339.4 strong 2.00 0.06 28.8 Irregular purchases weak 2.91 0.51 204.7 strong 0.37 0.26 269.1 Variable — 2.38 0.37 157.88 HICP 2.12 2.12 1000.0 Source: Eurostat; own calculations.

4.1.2.3 The role of irregular purchases subject to strong competition reflects the trends in international trade and the structural changes occurring here. In 1995 two-thirds of manufacturing imports from non-euro area countries came from high-cost countries. By 2005 this proportion had fallen to 50 %. The decline is due to the United Kingdom, Japan and the United States, while the share of emerging economies and, to a lesser extent, the new Member States, has increased. Changes in exchange rates may also have encouraged/discouraged trade with partners in the euro area. Share of countries/groups of countries in imports to the euro area high-cost countries of which low-cost countries of which United States Japan United Kingdom China New Member States 1995 65.7 16.1 10.7 20.3 34.3 5 8 1997 65.2 17.7 9.6 21.2 34.8 5.8 8.4 1999 64.1 18.4 9.8 19.6 35.9 6.3 9.8 2001 60.2 18.1 8.5 18.6 39.8 7.9 11.6 2003 55.1 15.1 7.8 16.6 44.9 11 14 2005 50.7 13.9 6.7 15 49.3 14.8 13.1 Change 1995-2005 – 15.0 – 2.2 – 4.0 – 5.3 15.0 9,8 5.1 Source: European Central Bank, Monthly Bulletin, August 2006.

4.1.3 Prices have been much more volatile since 2002 than they were during the years preceding the introduction of euro notes and coins.

4.1.4 The level of household income also explains how price changes are perceived. In addition, different perceptions in the population may be reinforced by the increase in the number of people living on their own, who have only one salary/income to cover all their expenditure. The situation is particularly difficult for those with dependent children, the low-paid, the unskilled, women (who still suffer from discrimination in wages and employment) and those on flexible employment contracts.

4.1.5 It should be noted that the characteristics of the goods and services making up the HICP may change from one year to another to reflect an improvement in their quality, without their price being changed. However, as the index does not take account of such a change, this will be recorded as a fall in the price in the index (even though it is quite possible that the good or service is no longer available on the market in its previous form. The fall in price is then just theoretical and does not correspond to a real situation). According to the ECB, ‘The expenditure weight of items which typically improve significantly in quality on a frequent basis is estimated at around 8-9 % of the overall HICP’. Examples of this would include cars, computers and mobile phones.

4.1.6 It is also worth mentioning the practice of certain retailers and companies which took advantage of the introduction of euro notes and coins to round up their prices (rents), although some additional costs could be justified as a result of relabelling, etc. In other cases price rises had not been passed on immediately because operators preferred to ‘kill two birds with one stone’ and deferred the price increase until the changeover to the euro. Eurostat estimates that the changeover to the euro accounted for between 0.12 and 0.29 percentage points in the overall HICP of the euro area in 2002.

4.1.7 Finally, a number of isolated events, unrelated to the single currency, coincided with the changeover to the euro and may have contributed to an increase in perceived inflation. These include the steep rise in the price of oil (+ 35 % between December 2001 and April 2002) and the poor harvests caused by the severe winter weather in Europe, which also affected economies outside the euro area.

4.2 Psychological explanations

4.2.1 Consumers may be more sensitive to price rises than to price reductions, whatever the product involved, and this sensitivity may have been exacerbated by the leap in the dark that the new single currency represented, by the mistrust caused by the larger number of different prices displayed for the same product following the changeover to the euro and by the size of the expenditure linked to those goods and services that did go up in price (rent, food, petrol).

4.2.2 Because the housing costs of owner-occupiers are currently excluded from the HICP basket, the sharp rise in property prices in certain countries may explain the difference between perceived and actual inflation.

4.2.3 It is also the case that consumers who convert the euro price of a product they are planning to buy into the old national currency take as their reference point the price that applied before the introduction of the euro. This skews the calculation because the old price will no longer be up to date because of inflation (3).

4.2.4 Another point worth noting is that consumers, and indeed observers, commonly confuse changes in purchasing power with growing expectations as regards standard of living. Many indices suggest that consumers' expectations about the standard of living are driven up even more than before by frequent technological changes, the appearance of new products or services (which tend to be added to normal consumption), ever more sophisticated marketing and the speed with which consumer items become the accepted norm thanks to social pressure. So, for example, buying a GPS on top of your other consumer purchases, or substituting ready-washed or prepared vegetables for ordinary ones, may feel as if it depresses your purchasing power, but in fact the pressure on household budgets is due to expectations rising more rapidly than incomes.

4.3 Methodological explanations

4.3.1 The aim here is not to call into question the validity of the HICP, which is based on monthly observation and recording by the national statistical offices of over 700 representative goods and services, equivalent to nearly 1.7 million observations in 180 000 sales points a month.

4.3.2 However, it is important to remember that the harmonised index of consumer prices is the product of certain conventions, primarily as regards (1) the choice of the goods and services which will serve as indicators and will be used to compile the index, and (2) the weighting of each of these indicators.

4.3.3 However, as the following table shows, the structure of households' expenditure varies according to their income. The widest variations are to be found in expenditure on actual rentals for housing, which is five or six times greater for the 20 % of households that are least well off than for the richest 20 %, where properties may be either rented or owner-occupied. They therefore have a different view of changes in property prices. The poorest households also spend 81 % more of their income on food and non-alcoholic beverages, making them more susceptible to surges in food prices on the world markets. Richer households spend 67 % more on new vehicles than households in the first quintile. Given that the price of new vehicles increased much more slowly than the HICP in the period 2000-2008, they have benefited greatly from this favourable trend. Euro area — HICP = 1000 (2005) Average annual % increase (2000-2008 HICP = 2,3) 1st quintile 5th quintile Difference between 1st and 5th quintile (%) Average consumer expenditure (PPS) Weight in HICP Difference cp01 Food and non-alcoholic beverages 2.5 195 108 80.6 143.3 154.91 11.6 cp02 Alcoholic beverages, tobacco and narcotics 4.1 29 17 70.6 21.4 40.71 19.3 cp03 Clothing and footwear 1.4 54 62 – 12.9 60.3 74.20 13.9 cp04 Housing, water, electricity, gas and other fuels 3.1 325 251 29.5 278.9 150.50 – 128.4 of which: cp041 Actual rental for housing 1.9 134 24 458.3 53.8 63.50 9,7 cp042 Imputed rental for housing — 106 151 – 29.8 143.9 — cp05 Furnishings, household equipment and routine household maintenance 1.3 41 69 – 40.6 56.8 76.5 19.7 cp06 Health 2.5 31 42 – 26.2 35.7 41.67 5.9 cp07 Transport 2.8 92 146 – 37.0 125.6 153.31 27.7 of which: cp071 Vehicle purchases 1.2 23 70 – 67.1 48.1 47.93 – 0.1 cp08 Communications – 2.7 37 24 54.2 28.6 29.19 0.6 cp09 Recreation and culture 0.6 64 90 – 28.9 83.0 94.66 11.7 cp10 Education 4.0 7 10 – 30.0 8.7 9.49 0.8 cp11 Hotels, cafés and restaurants 3.2 42 67 – 37.3 55.2 93.19 38.0 cp12 Other goods and services 2.3 85 113 – 24.8 102.5 81.67 – 20.8 of which: cp121 Personal care 1.9 27 25 8.0 26.1 26.36 0.2 cp125 Insurance 2.5 44 63 – 30.2 55.2 18.60 – 36.6 Source: Eurostat; own calculations.

4.3.3.1 The table below shows the differences in the inflation experienced by groups at opposite ends of the revenue spectrum, depending on their consumption profile. It traces the gap between them since 1996. In the past 12 years the inflation affecting the poorest households has exceeded that of the richest six times. The opposite has been true three times and in three years there were no significant differences.

4.3.3.2 In addition to this structural effect, it appears that in times of rapidly rising food commodity prices the poorest households who buy cheap brands or shop at the hard discounters will be hit even harder because the food raw materials account for a higher proportion of the price paid by the final consumer (the share of packaging and marketing costs, etc. being smaller).

4.3.3.3 Moreover, the poorest households cannot reduce the impact of higher prices on their budget because their savings rate is structurally low and they have greater difficulty in obtaining credit. Indeed they are in danger of falling into the debt trap.

4.3.3.4 This finding also applies at Member State level because, as can be seen from the table below, households devote different proportions of their income to different categories of goods and services depending on their geographical location (island status entails high transport costs, for example) and their level of socioeconomic development (Romanian and Bulgarian families spend nearly three times as much of their income on food as their counterparts in other countries), etc. The two last columns show the extent to which the relative expenditure of each group of countries or within the euro area are homogeneous (the lower the coefficient of variation, the greater the homogeneity). While there are strong similarities between the countries of the euro area, this is less true of other groups of countries. This shows the limits of the HICP which, being based on average weightings, cannot, by definition, reflect the specific situation of different countries. The countries joining the euro area should not underestimate this point, given the implications for monetary policy and inflation. euro area (excl. Lux) 3 old MS outside euro area new MS outside euro area (excl. Cyprus, Malta + Slovenia) Cyprus, Malta Romania, Bulgaria coefficient of variation between these groups coefficient of variation within euro area Housing, water, electricity, gas and other fuels 26.11 30.57 22.86 15.33 25.15 0.23 0.10 Food and non-alcoholic beverages 14.24 11.06 25.85 18.17 37.88 0.50 0.18 Transport 12.94 13.82 10.22 15.60 5.73 0.33 0.16 Other goods and services 10.14 7.65 6.25 6.89 3.07 0.38 0.29 Recreation and culture 8.65 12.33 6.98 8.02 3.54 0.40 0.32 Hotels, cafés and restaurants 6.21 5.27 3.97 7.68 2.34 0.40 0.35 Alcoholic beverages, tobacco and narcotics 2.61 2.56 3.05 2.32 4.78 0.32 0.40 Furnishings, household equipment and routine household maintenance 5.77 6.34 5.00 8.30 3.39 0.31 0.13 Clothing and footwear 5.70 4.92 6.02 8.04 4.66 0.23 0.21 Health 3.53 2.12 3.54 3.89 4.07 0.22 0.44 Communications 3.06 2.73 5.21 3.16 4.72 0.29 0.17 Education 1.05 0.63 1.05 2.59 0.66 0.68 0.61 Note: no data available for Luxembourg.

4.3.4 Similarly, there is sometimes a considerable difference between the average structure of consumer expenditure and the way the indicators are weighted in the HICP. Thus, on average, households in the euro area spent 27.5 % of their income on housing, water and energy, yet this heading counts for only 16.3 % of the HICP. Health and insurance are also under-weighted. On the other hand, the HICP over-weights food, transport and the ‘hotels, cafés and restaurants’ heading.

Brussels, 9 July 2008. The President of the European Economic and Social Committee Dimitris DIMITRIADIS

(1) See EESC opinion on ‘Economic and social consequences of developments on the financial markets’, OJ C 10, 15.1.2008, p. 96, section 1.14.

(2) Banque Nationale de Belgique L'évolution de l'inflation en Belgique: une analyse de la Banque nationale de Belgique réalisée à la demande du gouvernement fédéral (The inflation trend in Belgium: any analysis by the Belgian National Bank carried out at the request of the Federal Government), Revue économique, 2008, p. 17.

(3) For example, I plan to buy a car at the end of 2002 and recall that the year before it would have cost me 100. I take 100 as my reference point today, but since then, inflation measured by the HICP has been 2.2, so the price I should use as a reference is not 100 but 102.2. If I do this in 2007 the gap will be even greater, because the price would be 114!