Mendel University Brno IMPACT OF PERCEIVED INFLATION GROWTH AND PERSISTANCE IN EUROZONE COUNTRIES ON CONSUMER'S (SAVING'S) BEHAVIOUR Lubor Lacina Svatopluk Kapounek Mendel University Brno Czech Republic Brno, November 27 – 28, 2008

Structure of the paper Motivation for the paper Model for estimation Empirical results Conclusions Suggestions for futher research

Motivation of the paper The aim of the paper is to identify factors influencing significant increase of perceived inflation in countries preparing for membership and later becoming the full members of eurozone. There is a lot of literature and empirical studies trying to explain the motives for increase and persistence of perceived inflation. The new approach to this phenomenon is applied in proposed paper. Given the high level of perceived inflation and the associated perception of a reduction in real income, this could cause consumers to tighten their belts and hold back on spending. The resulting overall weakness in consumer spending would in turn impact negatively economic growth.

Review of literature Döhring, B., Mordonu, A. (2007): What drives inflation perceptions? A dynamic panel data analysis. ECB (2007): Measured inflation and perceptions in the euro area. Lindén, S. (2005): Quantified Perceived and Expected Inflation in the Euro Area - How Incentives Improve Consumers Inflation Forecasts Gaspar, V.; Smets, F.; Vestin, D. (2006): Adaptive Learning, Persistence, and Optimal Monetary Policy

Perceived inflation impact on inflation expectations and other macroeconomic variables There is significant empirical evidence, that introduction of euro led in most of the countries to significant increase of perceived inflation. At the same time there was no rapid increase in prices monitored by official price indexes like HICP (harmonised index of consumer prices). “Notwithstanding the accuracy of the HICP as a measure of consumer price inflation, protracted divergences in the evolution of measured perceived inflation warrant close examination, given that perceived inflation might have an impact on inflation expectations and through it another macroeconomic variables.“ (ECB, 2007).

Inflation perceptions measuring balance statistic Bit - inflation perceptions in the consumer survey (questionnaire – around 26000 consumers) possible answers to the question on inflation perceptions A(1) „risen a lot“ A(2) „risen moderately“ A(3) „risen slightly“ A(4) „stayed about the same“ A(5) „fallen“ A(6) „do not know“

Development of perceived inflation in euro area Source: Eurostat/DG ECFIN

Countries entering analysis Eurozone – increase in perceived inflation and persistence at higher level compared with period before euro introduction Germany – significant increase and then decrease to pre-EMU levels France – significant increase and persistence at high levels Czech Republic – control country staying outside eurozone but potential member of eurozone

Development of HICP and perceived inflation in individual member countries of eurozone (1999 – 2006)

Inflation and consumption There is significant relation between inflation and consumption in case of significant income effects (significant increase in inflation) The increase of perceived inflation in most eurozone countries after introduction of euro and the persistence in the long period can have the same effect on consumption like the increase in HICP Change in consumption can negatively influence GDP growth

Real consumption expenditure in percent of GDP

Inflation perceptions quantifying balance statistic Bit as scale range from -100 to 100 proposed quantified measure of perceived inflation for country i at time t inflation perception (qualitative data)

Basic assumptions temporary shocks can have permanent effects (price and wage rigidities) negative effect of inflation on the real consumption expenditure (Real Balance effect - Pigou) close relationship between the real economic growth and real consumption expenditure close relationship between the physical behaviour and perceived intensity of the stimuli (Weber-Fechner law) (Gerrit A. (2008): How is perceived inflation related to actual price changes in the European Union?)

Empirical evidence of perceived inflation impact on consumption Ct = Yt – St Ct + Pt = (Yt + Pt ) - St NCt = Yt + Pt + (Pt* - Pt) - St Ct real consumption expenditure P*t perceived inflation NCt nominal consumption expenditure Pt HICP Yt real income (GDP) S t real savings Data: quarterly percentage change compared to corresponding period of the pervious year, 1996:Q1 - 2008:Q2 Significant causality (1% level) was found in EA, DE, FR, CZ only for NCt = Yt + (Pt* - Pt) - St 15

Source: Eurostat, own calculations

Discussion (suggestion for further research) aggregate consumption function and perceived inflation impact on the new Eurozone member states temporary shocks versus permanent effects on real output alternative methodological approach: Granger non - causality

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