In a classic experiment, people were asked who would be happier: someone who got a 2% yearly raise when inflation was zero or someone who got a 5% raise when inflation was 4%.In real terms, the first person is 2% better off, while the second earns only 1% more than before. Nevertheless, two-thirds of those surveyed said the person with the 5% raise would be happier and less likely to accept a job offer from a competing firm.
The 5% is simply a bigger number than the 2%. So it feels like a greater reward, even though inflation eats up more of it.
Another installment of “Why you should never rely on newspaper columnists, however reputable, in anything serious”.
“Inflation”, be it CPI or PPI, is an aggregate indicator. It is made up by a committee of economists, and is a mental construct. It does show something which might be important for an average consumer, which is another mental construct in mainstream economics.*
In real life real people’s preferences and world views and patterns of consumption and savings and sensitivities to change in prices of products and services – vary by wide margins.
*Along with such mental constructs as the “risk-free interest rate” and the “time preference” quotient, “inflation” is also a convenient tool that helps make formally divergent time series in economics converging in some sense.