Loss aversion and experiences of inflation

Few people believe that the officially published measure of inflation accurately captures their own experiences and problems - this is hardly a surprise since our own spending patterns will rarely correlate precisely with the weights used to calculate the consumer price and retail price index. But there is a real danger that the published inflation figures are losing credibility - and with it comes a risk of a larger-than-expected wage-price effect into 2009.

David Leonhardt writing in the New York Times links aspects of behavioural economics to the vexed question of just how high is inflation. A really interesting piece and well worth reading:

“Price increases are simply more noticeable — more salient, as psychologists would say — than price decreases. Part of this comes from the notion of loss aversion: human beings dislike a loss more than they like a gain of equivalent size. If you have to sell your house for less than you bought it for, you’re really unhappy. You hate that ground chuck now costs $2.83 a pound, but you didn’t notice that oranges are 31 percent cheaper than they were a year ago. There is also something particular to inflation that aggravates loss aversion. Price increases are obvious. But price declines are often hidden. The cost of an item stays about the same for years, while everything else gets more expensive and nominal incomes rise.”

The rest of his piece is here