ECB Research Bulletin: Common Inflation Assumptions Might Fail to Capture Socioeconomic Differences

23 July 2024

By Isabel Teles – FRANKFURT (Econostream) – Common assumptions regarding consumers' experience and expectations of inflation may not be accurately capture the variety of inflation perceptions among different socioeconomic groups, according to findings presented in a research bulletin published Tuesday by the European Central Bank.

‘Households differ widely in terms of their shopping behaviour, product choice and consumption basket and therefore end up experiencing very different inflation rates for supermarket goods– even within seemingly narrowly defined social groups, such as a given low-income group. Assumptions such as common real interest rates or common inflation expectations might thus be rather imperfect descriptions of reality’, the authors of the bulletin said.

Poorer households spend a larger share of their income in food, which reduces their purchasing power in periods of high inflation, the bulletin observed.

The main way in which households adjust to inflation is by choosing alternative products, but this does not prevent the impact of inflation from being felt over time, the bulletin said.

‘Households can offset some of the price inflation of products they normally purchase by switching to products that experience a relatively lower inflation rate’, the authors said. 'While they do indeed do so on average, they often switch to products that show a relatively higher inflation rate, i.e. products that are getting relatively more expensive.’

The authors noted that most inflation indices do not consider the ability of households to switch products, but concluded that the substitution of items did not significantly reduce the dispersion of inflation rates.

‘An alternative approach measures the change in expenditure required to maintain a constant level of utility. Measuring inflation by a cost of living index with constant preferences instead of a cost of goods index with a fixed basket of goods returns very similar inflation dispersion estimates’, the authors said.