What is inflation?
Broad increase in prices
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.
Some price changes are more important than others
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.Watch our inflation monster cartoon on price stability
Different people buy different things
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:
- everyday items (such as food, newspapers and petrol)
- durable goods (such as clothing, PCs and washing machines)
- services (such as hairdressing, insurance and rented housing)
Compare the price of the shopping basket from year to year
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 (base year)||Price (1 year later)||Price (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.
- List all the products in your basket and the quantities you consumed in a given year (this will be your “base year”).In our example we take just bread, coffee, haircuts and a winter jacket.
- Calculate the total expenditure for each of the products by multiplying the quantities purchased by the price you paid for them:150 loaves of bread x €1.50 = €225 100 cups of coffee x €2.40 = €240, etc.
- Add up the totals for all the products to get the total cost of consumption. In our base year it’s €850.4. Repeat steps 2 and 3 for the following years.
- Repeat steps 2 and 3 for the following years.Looking at the example you will see that, after the first year, some prices changed. The total cost of consumption has risen to €875. After the second year, it's €891.
- Divide the total cost of the basket in each subsequent year by the cost of the basket in your base year, then multiply the result by 100.One year later: €875 ÷ €850 x 100 = 102.9
- The annual rate of inflation is the percentage change from one year to the next.In the example, after one year the inflation rate is 2.9%. This is calculated as the price index for that year minus the price index for the previous year (102.9 – 100), divided by the price index for the previous year (100) multiplied by 100. For the following year it's (104.8 – 102.9) ÷ 102.9 x 100 = 1.8%.
Euro area inflation
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.
Inflation, price stability and the ECB
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
Comparable across countries
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.
Weight of products in the HICP
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.
How is the HICP calculated?
- Collecting prices – Every month, around 1.8 million prices are collected by price observers in more than 200,000 shopping outlets. This happens in nearly 1,600 cities and towns across the euro area. Prices are collected in each country for, on average, around 700 representative goods and services. The exact number of items sampled differs from country to country. For each product, several prices are collected from different outlets and in different regions. Example: book prices take account of various categories of books (fiction, non-fiction, reference, etc.) sold in book shops, supermarkets and by internet suppliers.
- Weighting product groups – Product groups are weighted according to their importance in average household budgets. To make sure the index remains relevant and reflects changing spending patterns, the weights are updated regularly. They are calculated based on the results of surveys in which households are asked to record what they spend their money on. The weights are national averages that reflect the expenditure of all types of consumer (rich and poor, young and old, etc.).
- Weighting countries – Countries are weighted according to their share in total euro area consumption expenditure.
Who calculates 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.
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:
- Price rises catch our attention more than stable or declining prices – Increases in prices also stay in our memory for longer. We tend to notice stable or declining prices less, although these prices also count when calculating the average inflation rate.
- We notice frequent, out-of-pocket purchases more – In recent years, the prices of some goods and services we buy frequently have increased above average. Examples of these are petrol, bread and bus tickets. We often pay too much attention to changes in the prices of these items when thinking about inflation. This may mean we end up overestimating the actual rate of inflation.
- We notice infrequent purchases and direct debits less – A substantial amount of our household budget is spent on goods and services that we buy less frequently. Examples are cars and holidays. There are also items we often pay for by automatic bank transfer (direct debits and standing orders), such as rented housing and telephone bills. We tend to notice these expenditures and changes in their prices less when thinking about inflation.
“Personal” inflation – The Harmonised Index of Consumer Prices (HICP) is based on an average basket of goods and services. This average basket is representative for all households. However, households that experience an above-average inflation may be more acutely aware of this than those that benefit from a below-average inflation.
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.
- Inflation rates are annual, but our memory goes back further – The HICP is usually reported as an annual growth rate. This means that the general price level for a particular period of time – say, January 2009 – is compared with the same period one year earlier – namely January 2008. When forming their perceptions, people may think back to prices several years ago. Over a long period of time prices tend to rise substantially, even with a low annual rate of inflation. For example, if the annual rate of change of the HICP is 2%, after 10 years the general price level will have increased by over 20%.
Price changes versus quality changes – We often consider changes in a product’s price tag as inflation. But sometimes the quality of the product changes at the same time. The HICP deals with this by subtracting the change that is due to quality.
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.
Consumer price inflation in the euro area since 1961
In the 1970s and 1980s inflation was high in many European countries. But since the mid-1990s, inflation rates have been significantly lower thanks to countries preparing for the launch of the euro and to the monetary policy of the ECB.
What is driving the latest inflation rate?
It’s not always the items whose prices change the most that have the biggest impact on the index. The rate of inflation also depends on the share of each product in average household consumption expenditure – in other words a product’s “weight”.
Explore the latest data with this interactive inflation dashboard
Check out the latest data and historical data going back to 1996. Take a look at individual countries and drill down into individual product groups. When you select a timeline, the development of inflation over time will be shown in an animation, month after month.