ABSTRACT
Following Simmons and Weiserbs (1992), Madsen (1996) and Papadia (1983), we make use of the survey conducted monthly under the aegis of the European Commission. In this survey, European consumers are asked the following questions regarding prices: “(i) Is the price level now compared to 12 months ago a) much higher, b) moderately higher, c) a little higher, d) the same, e) lower?” and “(ii) Do you expect prices over the next 12 months a) to rise faster, b) to show a similar rise, c) to rise less fast, d) to stay the same, e) to decline?”5 The first question is backward looking and relates to the price level as perceived by the consumer. We can use this question to calculate the so-called perceived inflation rate, as opposed to the “official” inflation rate based on published CPI statistics. The second question is forward looking, and aims to capture expectations of consumers regarding future inflation. The method we use for extracting measures of perceived as well as expected inflation is an extension of the method made popular by Carlson and Parkin (1977), requiring less restrictive assumptions, such as a priori assuming rationality and normality of inflation expectations. In this respect we extend the analysis of Bakhshi and Yates (1998) to 13 European countries or regions.6 The modifications to the Carlson-Parkin or CPmethod are described in more (technical) detail in Berk (1999). An informal description of our method is as follows. Within a cross-sectional sample of size N surveyed at time t, each agent i is presumed to answer questions about the future behaviour of prices at time t + 12 (in months) on the basis of a subjective conditional probability distribution. This distribution is conditional on the information set available to the consumer at t. Agents are then presumed to report that no change in the price level is expected if the expected future inflation rate falls within an interval centred around zero. Similarly, agents will report that no change in the rate of inflation is expected if their expectation falls within an interval centred on the price increase that they perceive to have occurred in the past 12 months. The boundaries of both intervals, denoted as the response thresholds, are to be determined by the data.
