Perception vs Expectation:Understanding consumer confidence levels


Efficient conduct of monetary policy depends on the way consumers form their expectations. As central banks’ primary objective nowadays is on achieving and maintaining price stability, monitoring inflation perceptions and expectations of economic agents and understanding their nature is extremely important for them. In particular, differences between subjectively perceived price levels expected price levels, and official inflation figures could impact consumer spending and saving behaviour, and thus affect overall macroeconomic outcomes. Inflation perceptions and expectations thus represent one useful indicator to predict future inflation.
What exactly is inflation?
Economists define inflation as a sustained increase in the price level of goods and services in an economy over a period of time.
However, the average consumer tends to think they are facing higher inflation than both measured inflation and the target inflation rate. This is a measure that is defined as perceived inflation and inflation expectation. Perceived inflation is the rate of inflation measured by a household opinion survey. It is a measure that takes into account the psychological aspect of consumer sentiment. The importance of this measure can be gauged by the weightage it holds while calculating ‘Consumer Confidence Indices’. The expectation indices account for a staggering 60% of the index while the current situation accounts for the remaining 40 %.
People in usual circumstances perceive inflation rationally and their perceptions and expectations become exaggerated in case of shocks, such as for instance a pandemic. This gap between perception and measurement has been more pronounced during the pandemic. The aim of this paper is to discuss the measurement of the gap (if any) between perceived and expected inflation on the basis of consumer survey data in India and to try and pinpoint the reasons for the same.
The perceived inflation and expected inflation numbers could be used as a powerful tool by policymakers and monetary policy authorities since it gives a clear picture of the levels of consumer confidence in the country. It has been noted through rigorous survey and study in other countries that the perceived inflation rates are higher than the actual price level prevailing in the country. Through this paper, we try to study the reason (both tangible and intangible) for the relation between perception and expectations.
While consumers may have a limited ability to store and recall specific prices, and even succumb to a number of biases in the way in which they form perceptions and expectations of global price changes, they do seem to have some feel for, and ability to judge and forecast, inflation.
The change in consumer confidence has the potential to affect real economic activities through the changes in business sentiments. Thus, the current and expected confidence on economic and personal financial situations, are of particular relevance for policy purposes.


Through this paper, we intend to study the contrast between consumer perceptions about inflation while directly comparing it with the real-world scenario. The main objective of this paper is to try and define how consumer perceptions influence expectations by conducting an analysis of the pre-pandemic era viz-a-viz the post pandemic era in which we live now.

This study shall entail a deconstruction of the Consumer Confidence Surveys as well as the Inflation Expectations Bi-Monthly Survey published by the RBI. We shall try and adopt a quantitative framework to highlight whether the pre Covid-19 pandemic expectations are actually in line with the current perception among Indian nationals.

This paper also proposes to study the perception and expectation pattern differences in median inflation rates which may be observed from city- to-city. We will also try and extend the study to find out the reason behind the difference in inflation perception pattern between developed and less developed cities in India, if any.


Inflation Expectation Surveys of Households (IESH) has been an ongoing practice of the Reserve Bank of India since September 2005. This survey draws out the qualitative and the quantitative responses on the expected price changes and inflation for periods of three months and twelve months. These are, without a hint of doubt, subjective assessments based on individual consumption baskets. Hence, they are quite varied from the official inflation data that is published by the government. Yet, one may say that rational expectations provide an elegant and powerful framework, which often dominates the dynamic structure of the economy and econometric politics evaluation.

Thomas Sargent expounds that “rational expectations models impute much more knowledge to the agents within the model than is possessed by an econometrician, who faces estimation and inference problems that the agents in the model have somehow solved”. The products that are in circulation and are in demand are influenced, to a certain extent, by the ability of the consumer to avail the products that have been presented to them. As such, the current market scenario pits producers against one another to rise up and become the apt choice that the consumer makes while initiating a purchase.

Yet some important questions arise here. Models of information rigidity cannot account for all of the deviation from rationality that is more often than not present in surveys.

Furthermore, the literature does not address whether these deviations from rationality are economically meaningful. The presence of informational inefficiencies, and the fact that inflation expectations are of consequence for future realized inflation, we may analyse that informational inefficiencies may be exploited to improve forecasts of realized inflation.

Therefore, a model selection algorithm is imperative to produce models of inflation expectations for both households and professionals. Coibion & Gorodnichenko offer some respite in the affair using regressions to decide amongst models of expectations formulation that allow for deviations from full rationality.

In order to model inflation expectations, one can refer to the boosting algorithm, introduced by Schapire. The algorithm is a shrinkage estimator; it builds a statistical model from a potentially very large set of regressors, shrinking the influence of regressors that do not co- vary with the dependent variable. In contrast to other linear shrinkage methods, boosting allows for a much more general relationship between a vector of covariates and the target variable.

Expectations about consumer inflation plays a humongous role in determining the macroeconomic outcomes. In our paper, Perception vs Expectations - Decoding the Consumer Confidence Levels in India, we have looked at the effect that perception of the consumer has on the reality of the market and have attempted to situate it in the current socio-economic frame of reference with special emphasis on the effects that post-pandemic milieu has had on consumer expectations.

This literature review will discuss the empirical relationship that persists between inflation expectations and consumers’ expenditure in the Indian economical context. A study of the quantitative data from Reserve Bank of India’s Inflation Expectations Survey of Households reveals that the persistent upward bias in household expectations is mainly the result of three types of asymmetries - the cross-sectional impact of aggregate price shocks, the effects of price changes of different categories of consumption goods and the adaptation of households to their expected inflation rates. It can be analysed that the rate of adaptation is directly proportional to the unexpected increase in inflation. Thus, the spending decisions of households are influenced by inflation and usually leads to planning for reduced spending in the future.


This paper adopted secondary data analysis of the Consumer Confidence Surveys, Monetary Policy Reports as well as the Inflation expectation Survey published by the Central Bank of India- RBI, in order to arrive at the insights. The above reports dated from February of 2019 to January 2021 were studied thoroughly.

The consumer confidence surveys of 4 cities, viz., Ahmedabad; Mumbai; Patna; and Thiruvananthapuram were considered. Perceptions and expectations on overall price situation and inflation have been obtained from the survey which approximately 5000 households responded to across 13 cities. The respondents are well-spread across the cities to provide good geographical coverage. The Consumer Confidence Survey provides the respondents three options: Will Increase, Stay the same and Will Decrease. The responses are then converted into a single quantitative number- Net Responses where:

Net Response = Positive perceptions (%) – Negative perception (%)

The RBI Consumer Confidence Survey asked the respondents to answer questions pertaining to Perception of Price Level. They include:

  1. How do you think the overall prices of goods and services have changed compared with one year ago?
  2. In which direction do you think prices will move one year from now?
  3. In which direction do you think prices will move over the next five years?
  1. How do you think economic conditions have changed compared with one year ago?
  2. How do you view the current economic conditions?
  3. How do you foresee economic conditions one year from now?

The graphs shown below illustrate the results collated from these bi-monthly surveys:

Inflation expectation

Inflation Expectation Forecaster

Chart I.4 shows the data from April 2020 and chart I.5 shows the data from October 2020. Headline inflation breached the upper tolerance band of the target in December 2019 and peaked in January 2020, before subsiding prices of vegetables, fruits and petroleum products produced a downward shift of 100 percentage points in February. The inflation in the near short term is likely to be conditioned by the occurrence of one-off cost-push effects on various elements of core inflation and on the COVID-19 outbreak.

Similarly, headline inflation breached the upper tolerance band of the target during JuneAugust 2020, propelled by propagation of strong upside pressures. Factors such as supply chain disruptions and higher taxes on petroleum products and other items resulted in these upward pressures on inflation in spite of extremely dampened demand conditions amidst the COVID-19 Pandemic.


Three months ahead median inflation expectations fell by 10 percentage points in the September 2020 round of the survey while one year ahead median inflation expectations remained unchanged. The percentage of respondents expecting the general price level to increase by more than the current rate rose for both horizons vis-à-vis the previous round. According to the Reserve Bank’s consumer confidence survey for September 2020, one year ahead inflation expectations remained at elevated level.


Consumers perceived that the current economic situation was significantly worse when compared to a year ago, but it improved from November 2020 round of the survey. Weak sentiments emanated from downbeat perception on the price levels even in the January 2021 round of surveys. The current perception compared with one year ago shows negative sentiment with a sign of improvement from the previous round of surveys. Also, the one year ahead expectations compared with current situation paints a dull picture by showing negative sentiments with a sign of deterioration as compared to the last round of surveys.

Pre Post Covid Perception

The data represented as graphs above was collated from the Consumer Confidence Surveys published by RBI. The graphs depicted above represent the net response of the consumer sentiment expressed in percentages.

The inference gathered that through March 2019 to September 2020, majority of the survey respondents opined that there shall be an increase in the price levels. Figure 4 illustrates that the one-year expectation figures of 2019 when compared to the current perception figure of 2020 are pessimistic in nature. The actual price level, due to the economic situations prevailing in the country, was much higher than what the citizens had foreseen would be the case.


In the period from March 2020 to June 2020, India saw itself in a state of complete lockdown. The effect of the onset of the pandemic can be seen in the fact that the net response of the percentage of respondents of the consumer confidence surveys who expected inflation to rise fell from a whopping 84.6% to 75.8%.


The gap between perceptions and expectations may be attributed to a wide range of tangible and intangible factors. As a consequence of the lockdown, we may suppose that a sudden spike in the demand for essential commodities was seen due to which a demandsupply gap was created, resulting in a continual increase in the inflation expectation from March to May- June of 2020 until the demand-supply gap was filled. This factor is the extent of price gouging in high-demand goods as panic buying and hoarding ensue (for example, sanitizers, masks, medical supplies, pain relief medications).


Another important factor which impacts this demand supply gap is the dependence on migrant workers. Prices of certain products (for example, agricultural goods) can increase if supply is disrupted because of labor shortages resulting from a decline in the number of migrant workers. A third factor is the extent of reliance on imported critical goods since this can expose countries to inflation from abroad or to pass-through if countries witness sharp


depreciations as a result of outflows driven by risk-off sentiments. This is bound to be especially important for emerging market economies and developing countries.

One of the intangible factors which seems to have an immense impact on this gap is Consumer Behavior. Households could also pay more attention to price increases than price decreases and periodic sales might play a role in this context. In addition, more attention could be given to large than small price changes and to frequent rather than rare price changes. The loss of purchasing power from rising prices has been found to have an outsized psychological impact. This phenomenon of risk aversion has been beautifully outlined by the Prospect Theory suggested by Daniel Kahneman and Amos Tversky in 1979.

Studies have found evidence of yet another behavioral explanation: namely, that

consumers’ inflation perceptions are more strongly influenced by the prices of goods they purchase frequently and goods that come under the basket of essential commodities—like food and gasoline. Another factor that could affect the inflation perceptions gap of some consumers is their understanding of inflation and the economic factors that influence it.

Improving their financial literacy could enhance their knowledge and serve to reduce the observed gaps.


Inflation Expectation v/s Perception

A study of the inflation expectation survey’s city wise split of consumer sentiment about price levels helped us to gain insight into how the geography and demography of a city affect the perception vs expectation figures. We shortlisted the cities of Ahmedabad, Mumbai, Patna and Thiruvananthapuram for further analysis.


The two graphs above depict the pre-pandemic and post pandemic figures for expectations of price levels. As seen above, the most striking insights come from the city of Mumbai and Thiruvananthapuram. For Thiruvananthapuram, the current perception levels are drastically lower than what the consumers had expected it to be a year from 2019. This impact could be due to the onset of the pandemic in March 2020. The data figures from the city of Mumbai, however, narrate a different story. The expected levels of inflation averaged at

7.13 percent in contrast to a whopping 8.6 percent current inflation perception figure. A similar trend was witnessed in Ahmedabad.

As for the city of Patna, it can be inferred that the current perception of median inflation followed the same trend throughout 2020 i.e., steady rise till July followed by a reduction in the month of September, however at a higher level than the expectations. At the outset, with Thiruvananthapuram being an outlier, it may be inferred that the current median inflation perception levels in 2020 saw a steady rise in the cities from the month of March to September while hitting the peak in the month of July.


As established earlier, the perception and expectations of consumer households are a powerful tool used by policy makers and monetary policy authorities since it gives a clear picture of the levels of consumer confidence in the country.

The main insight from the review is that the COVID-19 outbreak coupled with other factors such as hoarding, migrant labor force shifts, fundamental changes in the demand and supply structures for essential and non-essential commodities, downsizing in the private sector etc. has significantly impacted the consumer sentiment about inflation levels that currently persist and that which might persist a year on from today.

After reaching a historical low in May 2020 round around the peak of Covid-19 related lockdown and restrictions, the future expectations index increased for four successive quarters. However, the price level expectations of the citizens tell a different story since they express negative sentiments with a sign of deterioration as compared to the last round of surveys.

While consumers may have a limited ability to store and recall specific prices, and even succumb to a number of biases in the way in which they form perceptions and expectations of global price changes, they do seem to have some feel for, and ability to judge and forecast, inflation. Acknowledging and better understanding any gap

between perceived and expected inflation is, therefore, very imperative. Hence, it makes it all the more important to study these intangible factors for adept decision making.



Kartik Mittal, Mansi Gupta, Soumya Prakash & Tarang Kadyan

Gokhale Institute of Politics and Economics

M.Sc. International Business Economics and Finance (IBEF)


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