Impact of Inflation on Consumer Life Style.

At the level of aggregate expenditures, variables explaining consumption functions are usually deflated by price indices on the plausible assumption that consumers are influenced by variables in "real" rather than monetary terms[1]. This procedure may be appropriate for permanent income and life cycle theory approaches as developed by Friedman and Modigliani because, in the long run, consumers strive for the standard of living that can be reached by people of their education and income level, the standard of living being measured in terms of real estate and car ownership, ownership of household durables and so forth. But "evidence continues to accumulate that the assumption of consumers being influenced by variables in real terms rather than in monetary terms is contrary to fact and that consumers are subject to the money illusion"[2]. Branson and Klevorick, in an attempt to investigate the money illusion in the aggregate consumption function, come to the conclusion that, "in the short run, the price level has an independent effect on real consumption"[3]. Their conclusion is at least plausible for a period of "creeping" inflation. As long as the rise in nominal income is not matched by a compensating rise in the price level, consumers may not worry too much about rising prices. They are cognisant of their growing standard of living and may even be inclined to justify rising prices on the grounds that they are purchasing better quality products and services. This mentality of consumers may be expected to change in periods of lower increases in nominal income and growing rates of inflation. If the rate of inflation has been exceeding the long-run average for a number of years and if the economic outlook does not suggest a change for the... [ABSTRACT FROM AUTHOR]