CPI vs. University of Michigan's survey of consumers' inflation expectations
This FRED graph compares expected inflation and actual inflation. In recent years, expectations (in red) have been consistently above realizations (in blue). Why?
How people form expectations is a fascinating topic, as expectations drive so many economic decisions. One important point here is that, individually, we notice relatively few prices in an inflation measure. That is, individuals buy fewer goods than are included in the basket that determines the CPI. Also, we tend to recall only a few of the prices we encounter, in particular those that changed or changed more than we might have expected. (Read more about individual perceptions and bias.)
The graph below shows there’s quite a bit of variance in price changes across categories of goods. As expectations of future inflation are largely determined by perceptions of past inflation, the end result is an upward bias in expectations.
How these graphs were created: For the first graph, click on the CPI link on the FRED home page: Use the “Edit Graph” panel to change units to “Percent change from year ago.” Use the “Add Line” tab to search for “inflation expectation” and use the Michigan index. Restrict the sample period to start in 2017. For the second graph, start from the CPI release table, check the desired components, and click “Add to Graph.” Then use the “Edit Graph” panel to change the frequency of each line to “Annual, end of period.” Finally, in the “Format” tab, change graph type to “Bar”, close the tabs, and select period 2017-01-01 to 2020-01-01.
Suggested by Christian Zimmermann.
View on FRED, series used in this post:
We recently discussed some CPI categories that do not tend to have rising prices. Those examples were all linked to information technology. Here’s a wide variety of categories where prices can decrease or remain stable for long periods. For example, coffee is subject to wide fluctuations, including steep price drops. Apparel became disconnected from the CPI sometime in the early 1990s and remains largely constant. It is more surprising that cosmetics and musical instruments are also consistently below general inflation or even flat. In the motor vehicles category, some quality improvements only partially affect the overall price of motor vehicles; this is another example, much like computers, of a category that does not closely follow the overall path of the CPI.
How this graph was created: Start with the graph for the CPI, then add the other series. Change the color of the CPI line to black and thicken it to distinguish it from the many other series.
Suggested by Christian Zimmermann