Inflation is an increase in the prices of goods and services in an economy over a period of time. That means you lose buying power — the same money buys less, and is thus worth less.[1]

Another way to think about inflation is in the context of the value of a country’s currency, like the U.S. dollar. As prices rise, each dollar buys fewer goods and services. As the purchasing power declines, the general cost of living goes up.

The money which can buy 10 cup of coffees in 1970, only could buy 2 in 2021!

If the inflation means higher price, there should be lower sales, right? Yet, it couldn’t be the case all the time. To show an exception, let’s have a look iPhone sales over time!

As we see on the graph below, inflation has no direct relation on iPhone sales. The effect between 2015-2020, also the time for rise of Chinese competitors in the market. New competitors and high inflation together, only slows down the iPhone sales a little bit.

When we talk about calculating the inflation, to which price we should look? Car price? Food Price or shelter? What about medical expenses?

To solve this problem, one of the most common metrics created is Consumer Price Index a.k.a CPI.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. [4]

As the most widely used measure of inflation, the CPI is an indicator of the effectiveness of government policy. In addition, business executives, labor leaders and other private citizens use the index as a guide in making economic decisions. [5]

The content of the CPI is changing across the globe from country to country. However the main logic is similar: There is a “basket” of goods as a list and there are weights defined to each category and item in the baskets. The content of the basket and the weights are usually available on the websites of each government’s financial or statistical authorities.

When inflation changes, it effects many parameters from governmental strategies to consumer behaviors in daily life.

Generally speaking, higher inflation harms savers because it erodes the purchasing power of the money they have saved. However, it can benefit borrowers because the inflation-adjusted value of their outstanding debts shrinks over time.[7]

One of the ways for governments to control the inflation is changing the effective interest rate of Federal Reserves. By changing the interest rate, governments try to shape investment style of investors. But, is this change really effective on the inflation?

As we see in the graph there seem a correlation between two. If we would observe this relationship by a scatter plot:

Seems like there is a strong correlation between CPI and Interest rates. Let’s calculate!

cor(CPIvsFFER$EffectiveInterestRate,CPIvsFFER$CPI)

## [1] 0.7049207

As it can be understood from this value, interest rate policies are in a strong relationship with the inflation.

On the government level, especially strong economies like U.S. can be very effective on handling the inflation with the tools like changing interest rates to manipulate the market.

But, what about individual behaviors? If inflation is effecting that much our lives, what would be our first reaction? To be able to understand people’s reactions to inflation news, we looked to the Google searches with the keyword “Inflation Rate”.

Another way to see the same effect:

The graphs clearly show that, strangely, whatever the inflation rate is, people’s interest on inflation reduces in summer.

Maybe we all want to “free the mind” a little bit in the summer, who knows?

Besides the seasons,do we also have a sensitivity to the magnitude of the inflation?

To be able to understand this, we took OECD countries [9] over all CPI data to represent the most of the world economies and compared with worldwide “Inflation Rate” searches since 2004.

Strangely, even if the logic says inflation is either “high” or “low”, we don’t see a clustering in the graph. Instead, we see a direct correlation. If we would calculate this correlation, we also see a high correlation between these variables.

cor(x=CPISearchesLogic$OECD_CPI, y=CPISearchesLogic$WW_Searches)

## [1] 0.8875793

This could be an interesting finding for future research on the topic.

Maybe search reaction is the first and easiest action to get the news about inflation. But what happens after? Do we shape our decisions accordingly? If so, would there be a cultural effect on this?

To investigate this, we compared the 2 developed but culturally different countries:

To be sure that we are making an apple to apple comparison, let’s look first the CPI trend of both Germany and USA.

We can see clearly that the CPI trend of both countries are quite similar to each other over the years.

The net household saving rate represents the total amount of net saving as a percentage of net household disposable income. It thus shows how much households are saving out of current income and also how much income they have added to their net wealth.[8]

These graphs shows that unlike the U.S. people, German people and overall system in Germany, promotes clearly a stable percentage of saving nearly no matter the economical conditions. Which also indicates that German culture has more stability in their long term economical plans.

Even if the cultural behavior different in normal times, extraordinary times get people to the same point. Think more on the future!

Let’s also compare the household debts:

Even if Germany and U.S. has the similar inflation between 1995-2008, Germany slows down the increasing household debts starting by 2000. Yet, U.S. not gives the same reaction until the 2008 economical crisis is on the horizon. With the crisis, they reduced the debts dramatically to the levels of Germany.

2 big economies, 2 whole different reactions to stable economy and stable inflation. Yet, it seems, now also the U.S. is in saving mode than spending mode in general since 2008.

• Inflation effects everyone, including governments and individuals.
• The most common indicator of inflation is an index called CPI
• People are sensitive to the magnitude of the inflation in general, but maybe less in summer time!
• Effective Interest Rate is a powerful tool to control the inflation.
• People of similar economies don’t react to changes always similarly.
• Even if there are competitors and rising inflation, people still buys iphone!

1 - https://www.businessinsider.com/personal-finance/what-is-inflation