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Inflation only reflects part of reality.
Russia’s war of aggression against Ukraine has dominated public attention in Germany for weeks. Issues such as the coronavirus pandemic or inflation have moved into the background. And although support for the people in Ukraine is rightly the top priority, the economic consequences – and thus the financial impact on savers and investors – should not be completely overlooked.The sharp rise in fuel prices, Russia’s threats to halt gas supplies, disrupted supply chains and the loss of platinum deliveries from Russia – all of this is likely to result in a significantly higher inflation rate in the medium term.
Even though most Germans have not studied economics, the topic of “inflation” is deeply rooted in the German saving mentality. The hyperinflation of 1923 has become ingrained in collective memory as a financial catastrophe, and even though there are hardly any contemporary witnesses left, images of people burning bundles of banknotes in their stoves remain vivid to this day. The topic has even found its way into everyday language: people speak of the “inflation ghost” or the “teuro”.
Since inflation will continue to shape the agenda in the coming months and years, it is worth taking a closer look at how this key figure is calculated. In principle, the calculation of the inflation rate is quite simple: the price of a good or service is measured at the beginning and at the end of a defined period.
The earlier price is subtracted from the current price. The result is divided by the earlier price and multiplied by 100. For example: a television costs €1,000 at the beginning of the year and €1,080 at the end of the year. €1,080 minus €1,000 results in a difference of €80. Divided by €1,000 and multiplied by 100, this results in an inflation rate of 8 percent. However, the officially reported inflation rate is not based solely on the price increase of televisions. The Federal Statistical Office calculates inflation based on a so-called basket of goods. This is intended to represent a realistic selection of everyday goods.
The goods are weighted according to typical household spending patterns – for example, energy and food are given a higher weighting, as they usually account for a larger share of monthly household expenditure. The basket of goods is continuously updated.
For example, what use is the calculation if someone has just lost their job close to home and suddenly has to commute 100 kilometres? For this person, a realistic weighting of the basket of goods would look very different from that of the “average consumer”. The same applies to many other groups, such as homeowners (of whom there are hundreds of thousands in Germany), for whom the official inflation rate offers little comfort when a house that would have cost €300,000 in 2015 now costs €600,000 – while their income has not doubled over the same period.
Inflation made simple – but only at first glance
Since inflation will continue to shape the agenda in the coming months and years, it is worth taking a closer look at how this key figure is calculated. In principle, the calculation of the inflation rate is quite simple: the price of a good or service is measured at the beginning and at the end of a defined period.The earlier price is subtracted from the current price. The result is divided by the earlier price and multiplied by 100. For example: a television costs €1,000 at the beginning of the year and €1,080 at the end of the year. €1,080 minus €1,000 results in a difference of €80. Divided by €1,000 and multiplied by 100, this results in an inflation rate of 8 percent. However, the officially reported inflation rate is not based solely on the price increase of televisions. The Federal Statistical Office calculates inflation based on a so-called basket of goods. This is intended to represent a realistic selection of everyday goods.
The goods are weighted according to typical household spending patterns – for example, energy and food are given a higher weighting, as they usually account for a larger share of monthly household expenditure. The basket of goods is continuously updated.
What does the average consumer actually buy?
The basket of goods used to calculate inflation is intended to provide a realistic picture of what an average German household consumes each month and how much it costs. It consists of four main categories: food and non-alcoholic beverages, consumer goods such as alcohol and tobacco, clothing and footwear, as well as housing and energy costs. In addition, there are smaller categories such as education, communication and household appliances. That is the theory. In practice, however, many people in Germany wonder why the official inflation rate is “only” five percent while they still have “so much month left at the end of the money”. The criticism is that both the composition and the weighting of goods and services do not reflect the real needs of individuals.For example, what use is the calculation if someone has just lost their job close to home and suddenly has to commute 100 kilometres? For this person, a realistic weighting of the basket of goods would look very different from that of the “average consumer”. The same applies to many other groups, such as homeowners (of whom there are hundreds of thousands in Germany), for whom the official inflation rate offers little comfort when a house that would have cost €300,000 in 2015 now costs €600,000 – while their income has not doubled over the same period.