Price perception and inflation rate:

1

• Price perception and inflation rate
• what is real ?
• Jan Schmidt
• Director, DG ECFIN
• European Commission
• Brussels, 14 March 2005

2
OVERVIEW OF PRESENTATION

• EMU as a stability-oriented regime
• Consumer perceptions of inflation and the euro
  changeover
• Explanation of the discrepancy
• Conclusions

3
EMU as a stability-oriented regime

• The euro is part of a change of regime whose
  purpose is to ensure better macroeconomic
  conditions for sustainable growth and job
  creation (Art. 2 of the Treaty)
• One key element is the price stability objective
  of the ECB
• The ECB has been successful HICP inflation has
  been around 2 percent since 1999

4
EMU as a stability-oriented regime

• This is a great achievement compared to earlier
  periods (see chart)
• Inflationary expectations are well-contained,
  i.e. close to the 2 percent level

5
CPI Inflation rates (annual change)
6
Consumer perceptions of inflation and the euro
changeover (observations)

• The euro cash changeover brought changes in
  prices, but the overall impact was limited
• A comparison between actual and perceived
  inflation shows a growing discrepancy after the
  changeover
• The perceived inflationary impact raised many
  questions and resulted in a public debate (such
  as the teuro in Germany)

7
Consumers perceptions of inflation and the euro
changeover (measurement)

• The perceptions of inflation is an index built
  upon qualitative surveys asking some 20.000
  consumers about 15 issues among which how they
  perceive inflation developments
• By translating this qualitative information into
  a quantitative indicator, an index is built and
  can be compared to the observed HICP (Chart)
• Before the euro changeover, both indexes were
  closely related since the changeover of January
  2002, a strong disconnection has been observed

8
(No Transcript)
9
(No Transcript)
10
Consumer perceptions of inflation and the euro
changeover (results)

• The comparison of both indexes shows that
  consumers have significantly overestimated
  inflation, perceiving it around probably the
  double of what the HICP effectively registered
• According to Eurostat ex-post calculations the
  changeover would be responsible of only a
  marginal impact on the inflation between 0.1 and
  0.3 percentage points of the total annual
  inflation rate of 2.3 in 2002
• This means that most of the 2002 inflation rate
  is explained by other factors including increases
  in energy and food prices, tobacco tax increases,
  etc. not linked to the euro and affecting also
  non-euro Member States

11
Consumer perceptions of inflation and the euro
changeover (the new Member state dimension)

• Perceptions of a substantial impact of the euro
  changeover on inflation have been widespread over
  euro-area Member states
• In the new Member states, over two-thirds of
  people questioned have expressed concerns over
  the inflationary impact
• This justifies a search for explanations

12
Explanation of the discrepancy (small item
inflation)

• Both consumption theory and empirical work
  suggest that consumers form their inflation
  perception on the basis of some small but
  frequently purchased items which are subject to
  an increased number of price changes
• This means that consumers assess inflation with
  higher subjective weights attached to frequent
  purchases, thus their assessment diverges from
  the HICP

13
Explanation of the discrepancy (the small item
basket)

• While it is a fact that some categories of goods
  and services (haircuts, coffee, newspapers)
  registered higher price rises, their small
  weights in the total index explain why these
  rises were nearly compensated by other price
  development in major categories.
• This behaviour seems due to lower competition in
  these sectors, allowing sellers for taking profit
  of the changeover.
• Eurostat constructed a sub-index grouping a
  selection of some frequently purchased items. The
  index followed closely the perceptions of
  inflation by consumers (Chart 3)

14
(No Transcript)
15
Conclusions

• Consumer misperceptions are based upon the fact
  that some psychologically important categories of
  goods and services registered relatively strong
  price increases during the changeover
• This experience points to the need to make the
  changeover transparent to the public
• A strong information campaign would help.
  Specific efforts are also needed to develop
  confidence building measures and to enforce
  correct price conversion, such as code of conduct
  between consumers and retailers associations,
  dual price display, monitoring of prices