In a market economy, prices for goods and services can always change. Some prices rise; some prices fall. One speaks of inflation if there is a broad increase in the prices of goods and services, not just of individual items. As a result, you can buy less for €1. Expressed the other way around, a euro is worth less than it was before.
When calculating the average increase in prices, the prices of products we spend more on – such as electricity – are given a greater weight than the prices of products we spend less on – for example, sugar or postage stamps.
Every household has different spending habits: some have a car and eat meat, others travel solely by public transport or are vegetarian. The average spending habits of all households together determine how much weight the different products and services have in the measurement of inflation.
For measuring inflation, all goods and services that households consume are taken into account, including:
All the goods and services consumed by households during the year are represented by a “basket” of items. Every product in this basket has a price, which can change over time. The annual rate of inflation is the price of the total basket in a given month compared with its price in the same month one year previously.
|Quantities bought in the base year||Price
(1 year later)
(2 years later)
|per unit||total||per unit||total||per unit||total|
|150 loaves of bread||€1.50||€225||€1.30||€195||€1.60||€240|
|100 cups of coffee||€2.40||€240||€2.40||€240||€2.15||€215|
|1 winter jacket||€145.00||€145||€176.00||€176||€160.00||€160|
|Total cost of basket||€850||€875||€891|
* Consumer price inflation in the euro area is calculated every month by Eurostat. The Harmonised Index of Consumer Prices (HICP) covers, on average, around 700 goods and services. It reflects average household expenditure in the euro area for a basket of products. Full product range covered by the HICP and current inflation rates.
In the euro area, consumer price inflation is measured by the “Harmonised Index of Consumer Prices”, often referred to by its acronym of “HICP”. The term “harmonised” denotes the fact that all the countries in the European Union follow the same methodology. This ensures that the data for one country can be compared with the data for another.
The main task of the ECB is to maintain price stability. This it defines as an annual HICP inflation rate of below, but close to, 2% over the medium term. Why maintaining price stability is so important
Before the euro became our common currency, each country measured inflation using its own national methods and procedures. The introduction of the euro made it necessary to have a means of measuring inflation for the entire euro area, without gaps or overlaps and in a way comparable across countries. The HICP, supported by a set of legally binding standards, does precisely this.
The impact of a single price change on the HICP depends on how much households spend, on average, on that product.
Example coffee: coffee (together with tea and cocoa) has a weight of 0.4%. So, any change in its price will not have a big impact on the overall HICP.
Example petrol: petrol (together with other car fuels and lubricants) has a weight of 4.6%, meaning that the same percentage price change as for coffee will have an impact about ten times greater on the HICP.
… in the countries? Each euro area country has a national statistical institute. The institute calculates the HICP for its country.
… for the euro area? Each national statistical institute sends its figures to Eurostat, the Statistical Office of the European Communities. Eurostat then calculates the HICP for the euro area as a whole. Eurostat also ensures the quality of the national figures by monitoring compliance with the legally binding standards. For details, see Eurostat's HICP web pages.
Consumer surveys often show that people “feel” inflation to be higher than the actual price indices indicate. So what forms people’s perceptions of inflation? A number of academic studies have found the following:
Example: if petrol prices increase much more than the prices of other goods and services, people who use a car frequently may “feel” a rate of inflation that exceeds the HICP because their personal expenditure on petrol is higher than average. By contrast, those who use a car rarely or not at all will experience a lower “personal” rate of inflation.
Example: car prices may have gone up but new models often include, as standard, features that were previously sold as optional extras (for example, satellite navigation systems, air conditioning and airbags). In such cases, the price increase is due partly to an increase in quality and not only to inflation. If car prices went up, say, 5% on average but quality increases accounted for 1%, then the HICP would reflect a 4% increase for this product.