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.

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.

Euro area inflation

Harmonised index

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.

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.

How is the HICP calculated?

1. 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. more
2. 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.). more
3. Weighting countries – Countries are weighted according to their share in total euro area consumption expenditure. more

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's HICP web pages.

Explore data

Perceived inflation

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.