Opinion of the European Economic and Social Committee on The reasons for the difference between perceived inflation and actual inflation
Date: 2008-07-09
Institutions: European Economic and Social Committee
Subjects: ESC opinion, Economic and Monetary Union, economic analysis, euro, fixing of prices, inflation

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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

As already recommended by the Committee,

1.1
‘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. More-
over, 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.

In addition, following the example of the study carried out by the Belgian National Bank (2), the
1.1.1
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 objec-
tive 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 incor-
porating changes in housing costs into the inflation index will be completed quickly and will produce opera-
tional 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) 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.

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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).

Finally, the EESC recommends supporting the public institutions and NGOs which provide informa-
1.6
tion 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.

Until the introduction of the euro, consumers' perception of inflation broadly corresponded to that
2.3
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 infla-
tion has stabilised around a level higher than that recorded in 2001.

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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 infla-
tion 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 econo-
mies. 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 appro-
priate, 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 coun-
tries, 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

Denmark

Sweden

United Kingdom

1.00

0.52

1.00

0.67

0.35

1.00

0.67

0.47

0.47

1.00

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Correlation matrix, 2002-2004

Euro area

Denmark

Sweden

United Kingdom

Source: Eurostat; own calculations.

Euro area

Denmark

Sweden

United Kingdom

1.00

0.29

1.00

0.78

0.34

1.00

0.80

0.40

0.75

1.00

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
three non-euro countries is stronger with the euro area than among themselves.

It is also striking that, with the exception of the pair Denmark-UK, the correlation between these

This shows that the price movements within the euro area cannot be attributed to the euro, because

3.2
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

cp01 Food and non-alcoholic beverages

cp02 Alcoholic beverages, tobacco and narcotics

2.31

4.47

3.11

1.99

1.50

5.42

cp03 Clothing and footwear

0.64

– 0.09

cp04 Housing, water, electricity, gas and other fuels

cp05 Furnishings, household equipment and routine
household maintenance

cp06 Health

cp07 Transport

2.81

1.68

1.59

1.49

2.19

1.12

4.93

2.51

cp08 Communications

– 5.07

– 0.73

cp09 Recreation and culture

1.22

0.10

157.91

39.71

75.87

154.96

79.84

36.04

153.67

28.23

98.10

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Euro area

2000-2002

2002-2004

Price
acceleration

Average
weighting
2000-2004

cp10 Education

cp11 Hotels, cafés and restaurants

cp12 Other goods and services

Source: Eurostat; own calculations.

3.46

3.69

2.86

3.49

3.23

2.53

9.21

91.25

75.25

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.

It is clear from the table that, overall, the prices of indicators which are subject to weak competi-
4.1.2.2
tion 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

Irregular purchases

Variable

HICP

Source: Eurostat; own calculations.

weak

strong

weak

strong

—

2.34

2.00

2.91

0.37

2.38

2.12

0.92

0.06

0.51

0.26

0.37

2.12

339.4

28.8

204.7

269.1

157.88

1000.0

The role of irregular purchases subject to strong competition reflects the trends in international
4.1.2.3
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.

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Share of countries/groups of countries in imports to the euro area

of which

of which

high-cost
countries

United
States

Japan

United
Kingdom

low-cost
countries

China

65.7

16.1

10.7

20.3

34.3

65.2

17.7

64.1

18.4

60.2

18.1

55.1

15.1

50.7

13.9

9.6

9.8

8.5

7.8

6.7

21.2

34.8

19.6

35.9

18.6

39.8

16.6

44.9

15

49.3

14.8

13.1

New
Member
States

8

8.4

9.8

11.6

14

5

5.8

6.3

7.9

11

1995

1997

1999

2001

2003

2005

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
introduction of euro notes and coins.

Prices have been much more volatile since 2002 than they were during the years preceding the

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.

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Source: ‘Measured inflation and inflation perceptions in the euro area’, ECB Monthly Bulletin, May 2007, pp. 63-72

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 situa-
tion). 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 chan-
geover
to the euro accounted for between
0.12 and 0.29 percentage points in the overall HICP of the euro area in 2002.

to the euro. Eurostat estimates

the changeover

that

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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 tech-
nological changes, the appearance of new products or services (which tend to be added to normal consump-
tion), 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

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

However, it is important to remember that the harmonised index of consumer prices is the product
4.3.2
of certain conventions, primarily as regards (1) the choice of the goods and services which will serve as indi-
cators 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 prop-
erty 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.

(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 refer-
ence is not 100 but 102.2. If I do this in 2007 the gap will be even greater, because the price would be 114!

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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

2.5

195

108

80.6

143.3

154.91

11.6

4.1

1.4

3.1

29

54

17

62

70.6

21.4

40.71

19.3

– 12.9

60.3

74.20

13.9

325

251

29.5

278.9

150.50

– 128.4

1.9

134

24

458.3

53.8

63.50

9,7

—

106

151

– 29.8

143.9

—

41

31

92

23

37

64

7

42

85

27

44

69

– 40.6

56.8

76.5

19.7

42

– 26.2

35.7

41.67

5.9

146

– 37.0

125.6

153.31

27.7

70

24

90

10

67

– 67.1

48.1

47.93

– 0.1

54.2

28.6

29.19

0.6

– 28.9

83.0

94.66

11.7

– 30.0

8.7

9.49

0.8

– 37.3

55.2

93.19

38.0

113

– 24.8

102.5

81.67

– 20.8

25

63

8.0

26.1

26.36

0.2

– 30.2

55.2

18.60

– 36.6

cp01 Food and non-alcoholic
beverages

cp02 Alcoholic beverages,
tobacco and narcotics

cp03 Clothing and footwear

cp04 Housing, water, electri-
city, gas and other fuels

of which: cp041 Actual rental
for housing

cp042 Imputed rental
housing

for

cp05 Furnishings, household
equipment
routine
household maintenance

and

cp06 Health

cp07 Transport

1.3

2.5

2.8

of which:
purchases

cp071 Vehicle

1.2

cp08 Communications

– 2.7

cp09 Recreation and culture

cp10 Education

0.6

4.0

cp11 Hotels,
restaurants

cafés

and

3.2

cp12 Other
services

goods

and

2.3

of which: cp121 Personal care

cp125 Insurance

Source: Eurostat; own calculations.

1.9

2.5

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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.

This finding also applies at Member State level because, as can be seen from the table below,
4.3.3.4
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 impli-
cations 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

26.11

30.57

22.86

15.33

25.15

0.23

0.10

14.24

11.06

25.85

18.17

37.88

0.50

0.18

Housing, water, electricity,
gas and other fuels

Food and non-alcoholic
beverages

Transport

12.94

13.82

10.22

15.60

5.73

0.33

0.16

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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

Other goods and services

10.14

Recreation and culture

Hotels, cafés and restau-
rants

Alcoholic
tobacco and narcotics

beverages,

Furnishings,
equipment
household maintenance

household
routine

and

Clothing and footwear

Health

Communications

Education

Note: no data available for Luxembourg.

8.65

6.21

2.61

5.77

5.70

3.53

3.06

1.05

7.65

12.33

5.27

2.56

6.34

4.92

2.12

2.73

0.63

6.25

6.98

3.97

3.05

5.00

6.02

3.54

5.21

1.05

6.89

8.02

7.68

2.32

8.30

8.04

3.89

3.16

2.59

3.07

3.54

2.34

4.78

3.39

4.66

4.07

4.72

0.66

0.38

0.40

0.40

0.32

0.31

0.23

0.22

0.29

0.68

0.29

0.32

0.35

0.40

0.13

0.21

0.44

0.17

0.61

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