How to Define the Consumer Perceived Price Index? An Application to Polish Data

Abstract

Inflation perceived by consumers may differ from official statistics, particularly due to different baskets of goods and services that lay people and statisticians consider and due to consumer loss aversion to price increases. Such effects, as suggested by the prospect theory, are confirmed in many empirical studies showing that consumers’ perceptions are substantially influenced by prices of frequent purchases and that price increases are perceived more strongly than price reductions. Following those observations, alternative consumer price indices were proposed, such as the out-of-pocket price index (ECB 2003) or the index of perceived inflation (Brachinger 2006, 2008). They proved particularly useful in interpreting a jump of inflation perception in some of the Economic and Monetary Union (EMU) economies after the euro introduction. The role of price changes of frequently bought goods and services in determining consumer opinions on price changes also seems significant in Poland, as revealed especially after its accession to the European Union (EU) in 2004. To assess whether their impact on subjectively perceived price changes is of a systematic nature, in this paper we develop different types of indices of price changes that are likely to influence consumer opinions on observed price developments. Then we evaluate them in terms of their impact on consumer inflation perception, as proxied with survey data, and define on this basis the best-performing index, called the consumer perceived price index (CPPI). The results suggest that Polish consumers observe a relatively wide range of goods and services and that both factors suggested by the prospect theory seem to influence their opinions on the evolution of prices in the past.

Acknowledgments

The authors thank Danuta Kołodziejczyk and Ewa Stanisławska as well as the participants of the 2013 International Symposium on Forecasting (Seoul, 23–26 June 2013), the 2013 EcoMod Conference (Prague, 1–3 July 2013), the First Kassel Workshop on Folk Economics (Kassel, 2 July 2013), and the sixth international conference “Economic Challenges in Enlarged Europe” (Tallinn, 15–17 June 2014) for discussions and helpful comments. Opinions expressed in this paper are of the authors and do not necessarily represent the views of the National Bank of Poland.

Notes

¹ However, we should underline that after the launch of the euro consumers in many of the euro area economies became more optimistic about future price developments (Łyziak 2010).

² There were also other factors affecting consumer opinions on observed price changes, such as recalculation of prices to former domestic currencies and rounding effects or the tendency to confirm previous strong expectations of price increases after the euro introduction (Stix 2005).

³ Similar indices were used by Łyziak (2009).

⁴ The Polish Central Statistical Office (GUS) uses the household consumption structure from the previous year as the base period.

⁵ As in the case of previous indices, we calculate year-on-year price dynamics using GUS methodology.

⁶ Alternatively, we modified this method by introducing three intervals of price changes, applying different values of the parameter c for each of them. In this way we consider separately nonpositive or negligible inflation, moderate inflation, and high inflation. The bounds of these intervals—1.5% and 3.5%—are based on the limits of the interval of tolerated deviations from the inflation target of the National Bank of Poland (2.5%).

⁷ A similar measure used by the ECB (2003) is based on price changes of the following groups of goods and services: nondurable goods and daily consumer services (i.e., food, beverages, tobacco, nondurable household goods, transport services, fuel, postal services, hotels, restaurants, cafés, and hairdressing).

⁸ It should be noted that in moving from the first index (which covers only one item) to the last one (which covers 51 items), the volatility of subsequent indices decreases.

⁹ This outcome, which may seem surprising, is quite easy to explain. When calculating IPI indices, we multiply the weight of an item with positive price dynamics by the constant c, which is bigger than 1. It means that we assign relatively higher weights to the items whose price dynamics are closer to the mean (3.5%). At the same time, we give relatively lower weights to negative price dynamics significantly below the average. By doing so, we lower the variability of the whole index.

¹⁰ A detailed description of the European Commission Consumer Survey is provided by EC (2006, 2007).

¹¹ As far as inflation expectations are concerned, the seminal article by Carlson and Parkin (1975) argues that survey respondents have a similar information set, which contains publicly available professional forecasts, so a unimodal distribution of their expectations around the consensus can be expected. The authors claim that if individual distributions are independent across respondents and have a common form and finite first and second moments, the survey results can be interpreted as a sampling from some aggregate distribution, which under the central limit theorem is normally distributed. Similar assumptions can be used in the case of inflation perceptions.

¹² There is one important obstacle in using the probability method relevant for some of the measures we quantify in the paper, which appears when the scaling factor of the quantification method becomes nonpositive. The use of a formal algorithm for adjusting the probability method in such circumstances (Łyziak 2013) would be time-consuming given the number of measures of perceived inflation we quantify; therefore we apply a simpler method. If in a given period the moderate inflation becomes nonpositive, we replace it with the minimum positive value observed in the sample period.

¹³ The results are similar when using balance statistic $B{S}_2^p$; therefore we do not report separately results based on this statistic.

Additional information

Notes on contributors

Aleksandra Hałka

Aleksandra Hałka is director of the Bureau of Inflation Analysis at the Economic Institute, National Bank of Poland.

Tomasz Łyziak

Tomasz Łyziak is director of the Economic Research Bureau at the Economic Institute, National Bank of Poland.