'Real-Feel' Inflation: Quantitative Estimation of Inflation Perceptions

Abstract

The state of inflation expectations is generally supposed to influence actual inflation and therefore policymaker actions to maintain price stability. However, the methods usually employed to evaluate inflation expectations are insufficient. Survey methods either record economists’ forecasts of official CPI, or consumers' flailing attempts to calculate the weighted average price increase personally experienced in a consumption basket consisting of hundreds of items purchased at different intervals (and the latter survey results do not mesh with anecdotal evidence that most consumers believe the inflation they face is higher than the official CPI). In this paper, I propose functional forms for several adjustments that can be made to reconcile official price measurements with consumers’ perceptions. These adjustments are corrections for cognitive biases related to loss aversion and mental accounting. I identify several other biases that may be candidates for research into additional adjustments.

Keywords: inflation, inflation expectations