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Everybody Always Thinks Inflation Is Higher Than It Really Is

Filed by KOSU News in Business.
August 15, 2012

The world is going to hell, and prices are going through the roof. This, more or less, seems to be the perpetual conventional wisdom.

The first half of the statement is debatable. But the second half is clearly wrong right now: Prices are not going through the roof.

Prices for U.S. consumers rose by just 1.4 percent over the past year, according to the consumer price index numbers released this morning. In other words, inflation is very low.

If this comes as a surprise, don’t be surprised. In study after study, in country after country, economists have found that consumers overestimate inflation.

It’s not clear why this is the case.

Maybe it’s because when consumers think about inflation, they think about stuff they buy all the time — stuff like groceries and gasoline. But gas accounts for only 5 percent of the average household’s budget, while groceries make up 9 percent.

And over the past few decades, prices for more expensive things that people buy less often — stuff like cars, furniture and electronics — have risen more slowly than prices for stuff people buy all the time. As a result, consumers have tended to over-estimate inflation. (For more on this hypothesis, see this study.)

There’s also this: Everybody talks about food and gas prices when they’re rising. Think of gas prices in the past few weeks, and earlier this year. But, somehow, we don’t hear so much about gas prices falling, as they did for much of the spring.

“People focus on bad news more than they focus on good news,” Paul J. Healy, an Ohio State University economist who has studied how people perceive inflation, told me. “When prices go up, they notice it. When prices go down, they don’t care.” [Copyright 2012 National Public Radio]

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