The Perceived Inflation Wedge -- by Neville Francis

Standard measures of inflation, such as the Consumer Price Index (CPI), are designed to measure changes in the cost of living, not how households perceive price changes under limited attention and imperfect information. This paper introduces Perceived Inflation (PI), an attention-weighted inflation measure derived from a model in which households allocate attention across goods and observe noisy price signals. I construct monthly PI using disaggregated CPI data and attention proxies based on price salience, volatility, media mentions, and search behavior. The resulting PI series is highly correlated with CPI inflation but exhibits greater short-run volatility, especially during the Global Financial Crisis, the COVID-19 recession, and the 2021–22 inflation surge. A state-space version of the index implies a persistent latent attention component and a time-varying PI wedge. Finally, the paper embeds the estimated PI wedge into a heterogeneous-household model to demonstrate how attention-driven distortions in inflation perceptions affect saving and consumption through perceived real returns.