Seeing is believing when it comes to inflation

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Perceptions of inflation are formed, not by the ONS, but by the most salient prices.

According to the official figures released last week, the UK consumer price index increased by 3 per cent over the previous 12 months. I do not know anyone who believes that figure. There has always been scepticism about official measures of inflation, but the gap between popular perceptions and the government’s statistics has never been so wide.

The popular newspapers have sent intrepid reporters down to the shops to discover the truth, by filling a typical shopping basket. The results are “alarming”, “the most savage increase in living costs for a generation”. The Daily Express found an 11½ per cent increase in prices, the Daily Mail put it at 15 per cent.

Yet what the Office for National Statistics does is just what the Express and Mail did, except that the ONS does it much more carefully. The government statisticians begin from a survey of households to establish spending habits. A team of mystery shoppers is conscientious in seeking out the range of prices of the carefully defined content of the official shopping basket. Back in the office, the statisticians try to adjust for changes in product quality and the changing composition of expenditure.

Any price index is an average, and an average disguises a range of experience. Prices rise at different rates. When inflation is at 20 per cent, as at times during the 1970s, it does not seem to matter much that some items have increased by 22 per cent and others by only 17 per cent. But such differences seem much more significant when the average is 2 per cent: similar dispersion would imply that some prices were increasing at 5 per cent while others were actually falling. In this latter world, it hardly makes sense to talk about a rate of inflation, rather than an average price increase.

The range of price variability has increased as inflation has receded. There is what might be termed “the China effect” – the productivity of newly industrialising nations has reduced the prices of many manufactured goods. More competitive domestic markets have also had an impact. Many prices used to rise year in, year out, in line with or slightly ahead of general price inflation – items once produced by nationalised industries, such as electricity, or by cartels, such as air travel.

But perceptions of inflation are formed, not by the ONS, but by the most salient prices. The price of petrol is highly salient: not only do people buy petrol regularly, but even when they are not buying it, they routinely pass signs that display the price. We are most observant of the prices of goods we buy regularly and often and of the cost of undifferentiated products, such as petrol or milk, for which price comparisons are easier and likely to stick in our minds. Utility prices are salient – with the exception of telecoms whose price structure is bewilderingly complex.

Price falls have been most marked for goods benefiting from the China effect or technical change, and few of these prices are easy to track. The ONS survey identifies four categories of expenditure, accounting for 16 per cent of total spending, whose prices have fallen in the past year. Telecoms is one. The other categories are clothing and footwear, furniture and electrical items, and cars. All these products are heterogeneous, none of them are weekly purchases. Most people probably have a vague sense that prices of these sorts of items have not gone up much, but have no overall picture. The Daily Express survey includes only one such item – a pair of children’s shoes. The Daily Mail reporters did not buy any such goods.

The recent burst of inflation has particularly hit salient prices such as petrol, gas and electricity. Food prices, on average stable over several years, have risen sharply. That is why perceptions of inflation run so far ahead of the actual average increase in prices. Yet inflation expectations are governed, not by statistics, but by experience. Confidence affects consumer behaviour and inflation expectations feed into future prices. The amateur inquiries of the Express and Mail tell us little about the present. But they focus on what is most visible. So they may be a more illuminating guide to the future than the careful analysis of the professional statistician.

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