Why don't we believe official inflation figures?

Inflation  credit: Tali Bogdanovsky
Inflation credit: Tali Bogdanovsky

The Consumer Price Index was flat in January, but many people feel that prices are rising steeply. "Globes" examines the discrepancy.

At the end of last week, the Central Bureau of Statistics reported that the Consumer Price index (CPI) was unchanged in January. The annual inflation rate fell to just 2.6%, bringing it below the upper limit of the Bank of Israel’s 1-3% target range for the first time in eighteen months. Many Israelis feel, however, that prices have actually risen by much more, and that the CPI does not reflect reality.

For example, what is the significance of a 7.6% decline in air fares in January, which helped to depress the general CPI, at the height of a war? Does that say anything about the cost of Israelis’ real purchases?

This is not the first time in recent years that this discussion has arisen. During the Covid pandemic, there were sharp changes in consumption patterns, more extreme than now: no-one travelled, no-one went out to restaurants, and people bought much more online. Nevertheless, a study published by the Bank of Israel for 2020 found that, even after adjustment for the new consumption patterns, the CPI would have risen by only another 0.2%. In other words, there was an effect, but a fairly negligible one. Dr. Itamar Caspi, head of the Monetary Analysis Unit at the Bank of Israel's Research Department, and one of the authors of the study, explained in the past that "there is an exaggerated fear of errors in the calculation of the CPI." He said that the problem did not necessarily lie with the CPI itself, which he said "is calculated in accordance with recognized, up-to-date international standards," but with the public’s biased perception of price changes.

A global phenomenon

Caspi also explained that people are much more sensitive to purchases they make frequently, such as food, than to purchases they make once in a while, such as clothing or home renovations. A study by the San Francisco branch of the US Federal Reserve demonstrated that prices of day-to-day purchases, particularly of fuel and food, have an exaggerated effect on consumers’ perceptions.

So in a period in which prices of these items are rising, people will feel that inflation is much higher than it actually is, and will also erroneously predict high inflation in the future. When, according to the Central Bureau of Statistics, food prices have risen by 5.2% in the past year, and prices of fresh produce have risen by no less than 13.4%, and the excise duty on fuel has been completely restored, it’s clear why people feel that everything around them is becoming dearer. Moreover, Caspi reminds us, "No household in Israel buys exactly the basket of products on which the CPI is based. A rise in prices of basic products will be felt more by low-income households, and rise in the price of fuel will be felt more by people who drive a long way to work."

In fact, the disjunction between how inflation is perceived and the actual inflation rate is a global phenomenon: a study of perceptions of inflation in the euro bloc found a huge gap between the public’s perception of inflation between 2005 and 2014, which averaged 9.5%, and actual inflation in that period, which was just 1.8%.

Heightened attention

Merav Yiftach, director of the consumer prices sector at the Central Bureau of Statistics, claims that one factor at play here is bias on the part of the press and media towards coverage of prices that rise, and that product prices that don’t rise, or even fall, receive much less coverage.

Meitav Dash chief economist Alex Zabezhinsky also explains the gap between consumer perceptions and the dry data as being partly due to media bias. "It happens a lot," he says. "Announcements by the food companies of price rises reverberate in the media, but only affect prices slightly. This is both because they sometimes relate to only a small proportion of the company’s products, and because retailers close on a different price with the food company itself, or reduce the price of their own brand. In practice, you don’t necessarily see the announced price rise in the stores."

In addition, following the many announcements of price rises in the past month, Yiftah points out that "prices that rise in February will only be reflected in the CPI reading released next month."

Caspi too said in the past, "Some of the gap between public sentiment and low official inflation figures can be explained by the rise in the level of attention that the public pays to inflation after a decade of stable, low inflation rates. In addition, the gap is also connected to the fact that the particular inflation rate experienced by each household may be different from the official rate, since it depends on the household’s own special characteristics."

It’s important to remember that the CPI reflects prices of many components that some consumers don’t see. An owner occupier, for example, will not see a substantial portion of the housing component in the CPI, which includes rents. The housing item represents 26% of the CPI, but two-thirds of Israeli households own at least one home, and so the heaviest part of the rise in the cost of living in Israel may not affect them.

Nevertheless, Mizrahi Tefahot Bank chief markets economist Ronen Menachem estimates that we shall see the consequences of recent price rises in the next CPI reading. "Since demand for food is rigid, then to the extent that the price rises are applied and remain in place, there will be an effect later on."

Even now, Menachem says, were it not for the food item, we would have seen a fall in the CPI reading for January. "The food item rose by 0.2%, while the general CPI remained unchanged. This item represents 15% of the CPI, and so contributed 0.05% to it, and prevented it from falling.

The war will yet have an effect

In any event, many analysts see the price rises reaching the Central Bureau of Statistics’ official figures soon. Leader Capital Markets chief economist Yonatan Katz says, "In the past few months, we have seen the war have a moderating effect on inflation in the short term, but inflation is expected to accelerate somewhat as the year goes on. Some imports, cars for example, will become more expensive, because of higher shipping costs. Rents are also expected to rise in the second half of the year, because of a shortage of housing, and demand on the part of many people evacuated from the war zones. This is in addition to rises in food prices in the coming months."

Katz says that the rise in the rate of VAT in January 2024, from 17% to 18%, will give the CPI a further push. Bank Leumi, however, is optimistic about the official inflation rate, and estimates that it will continue to moderate over the coming year, to an annual 2-2.5%.

Menachem says that price rises also depend on the public mood, on regulatory changes, and on changes in public taste. He says that if people see that food price rises are permanent, they may quickly switch to cheaper alternatives, which would force the big manufacturers and importers to moderate the price rises. According to Zabezhinsky, there is no justification at the moment for further price rises, and many companies are taking advantage of the war and people’s diverted attention to put up prices. "The agricultural inputs index and other elements in the food industry do not indicate rises in production costs," he says. "On the contrary, inputs are mainly falling in price, which strengthens the feeling that there is no basis for rises at present."

The Central Bureau of Statistics stated in response, "People’s perception that the CPI does not represent the change in the basket of consumables stems from several main mistakes. One of the mistakes is arises when companies declare price rises, and there is a feeling on the part of the public that ‘everything is going up,’ when in fact some companies that have announced price rises have retracted them.

"Another common mistake is connected to the effect of memory. As consumers, we tend to remember mainly the changes in prices of day-to-day product purchases. In fact, the CPI reflects the consumption of about 1,400 wide-ranging products and services which are not necessarily part of daily consumption, such as telecommunications products, education, culture, entertainment and sport, furniture, cosmetics, and more."

Published by Globes, Israel business news - en.globes.co.il - on February 19, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Inflation  credit: Tali Bogdanovsky
Inflation credit: Tali Bogdanovsky
Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018