The naked eye versus the CPI: How does our perception of inflation stack up against the data?

The naked eye versus the Consumer Price Index: How does our perception of inflation stack up against the data?

Anyone who has filled up at a gas station, shopped at a supermarket or paid a utility bill recently knows that prices are rising. The question is, by how much?

Every month, the Consumer Price Index (CPI) team at Statistics Canada gathers price data for more than 1,200 unique products and services from over 7,000 different stores and outlets across Canada. These data are crunched monthly to accurately calculate how prices have changed nationally and regionally from the previous month and from the same month a year earlier.

The average Canadian, by contrast, purchases a much smaller range of goods, often locally, from a handful of retailers. For this reason, among others, Canadians tend to overestimate the rate of inflation compared with the benchmark numbers that StatCan publishes monthly.

How do we know this? Every quarter since 2014, the Bank of Canada has asked consumers and businesses about their price expectations for the coming year and five years into the future. Over this period, Canadians have consistently overestimated the rate of inflation compared with the benchmark figures published monthly in The Daily.

This overestimation on the part of businesses and consumers happens not only in Canada, but around the world, including in the United States, New Zealand, Australia and Europe.

Psychological and behavioural factors play an important role in the tendency of Canadians to overestimate the extent of price changes. Views about inflation tend to be driven by large price changes, especially large increases—rising prices resonate more with consumers than declining or stable prices. Similarly, price changes for frequently purchased items, such as groceries and gasoline, have more influence on how we view inflation than price changes for durable goods purchased less frequently, such as cars or mattresses.

Different types of households also spend their money differently. For instance, the way you spend your money is affected by whether you have children, your age and the gender composition of your household. Because these sociodemographic factors influence how Canadians spend their money, they often also influence the inflation rate they experience.

On average, estimated inflation experiences are similar across age groups. However, youth have higher and more volatile inflation perceptions relative to other age groups.

Perceptions of inflation are also linked to household income and the share of the total income a household commits to life’s essentials. For example, lower-income households commit a larger share of their total spending to shelter (33.1%) compared with higher-income households (23.7%), but spend less on transportation (15.4% vs. 21.9%) and recreation, education and reading (9.9% vs. 12.8%). Higher prices for key goods, such as mortgage payments, heating costs and gas, which account for a large share of household spending, will have a larger impact on how someone views inflation than higher prices for other items, such as travel services, which may account for a smaller share of monthly spending.

Housing costs also tend to skew the perception of inflation, with the cost of purchasing the home often overshadowing how much it costs to maintain the home. The difference between the price of a house and the cost of owning a home can be a source of confusion that contributes to the gap between perceived and estimated CPI inflation. There are a few recommended approaches, but no consensus among national statistical organizations on how best to reflect the true cost of housing in their respective CPIs. It also depends on whether a home is considered a consumer good or an asset.

Product quality is also an important consideration when understanding inflation. To accurately measure pure price change, the goods and services monitored by the CPI product sample must be of comparable quality over time. However, the quality of certain products, such as electronics, cars or Internet services, is constantly improving, often in lockstep with higher prices for those goods. When StatCan measures price changes for these goods, it factors in the qualitative (or package size) changes. When consumers buy these goods, they are quick to note the price change, but do not necessarily consider the quality improvement that occurs over time.

Canadians with higher financial and economic literacy tend to have inflation expectations that more closely align with CPI data. StatCan has the data, tools and resources to help Canadians increase their knowledge about inflation and how it’s measured.

To learn more about inflation, check out the release Consumer Price Index: Annual review, 2021 and the infographic Consumer Price Index: 2021 in Review, highlighting the annual average consumer inflation in Canada and the regions in 2021.

The Personal Inflation Calculator is also a handy tool to calculate how your personal inflation rate compares with the rate for the nation as a whole.