28th August 2008
The Malta Independent - Friday Wisdom
The Malta Independent - Friday Wisdom
If you are confused about what the
real level of inflation is, I don’t blame you. This for three reasons. Firstly
because there are four different measures of inflation published every month.
Secondly because these measures attempt to calculate the general level of
inflation which are different from the individual’s own experience. Thirdly
because the tools used to measure inflation are imperfect and they tend to go
out of date rather quickly.
Let me try to unravel this complex issue. Every month we get four different inflation readings. The inflation results published for July 2008 can be seen in the table above.
The main difference between the RPI and the HICP is that the latter captures also hotel accommodation prices normally consumed by tourists. This element is not included in the RPI. There are also some minor differences in classification and weighting adjustments, which however leave very negligible impact on the overall result.
So the fact the HICP measure is higher than the RPI measure for the 12 months to July 2008 is positive in the sense that it shows that the economy is enjoying a buoyant tourist season permitting our hotels to increase their room rates.
The 12 months moving average measure smoothens out changes as rather than measuring the increase of the Index from a point 12 months ago to the same point this year, it measures the average of the last 12 months this time last year to the same average of the last 12 months. Accordingly price movements are more instantly reflected in the 12 months measure and will take time to get reflected in the 12 months moving average method.
Probably the RPI 12-month inflation measure is closer to readers’ personal experience but I still do not blame anyone who feels that in their case the real inflation is higher than the 4.80 per cent declared by the statistics. This is because the RPI averages out consumption patterns as they result from a nationwide household budgetary survey and one’s personal consumption pattern could vary substantially from the average.
Let’s take food as an example. This has a weighting of 23.82 per cent in the measurement of the RPI. Now this percentage could be too much for high income persons and could be too little for low income earners. People have to eat every day and there is a limit to how much they can eat even if they are rich. So food consumption as a percentage of total expenditure tends to vary inversely with the level of income. The higher the income the less one spends on food in percentage terms and vice-versa.
Given that food showed a 7.80 per cent increase in the year to July 2008 it is quite understandable that low income earners probably feel that their cost of living has gone up more than reflected in the RPI. On the contrary “water electricity gas and fuels” which increased by 31.29 per cent in the 12 months to July 2008 have a much higher impact on richer consumers than the 2.25 per cent weighting given in the index.
This brings me to the third point. The RPI is based on a Household Budgetary Survey which was collected seven or eight years ago. The HICP on the other hand has a base year 2005 but the weightings are reviewed annually for changes in consumption pattern as resulting from the National Accounts and such consumption includes not only private households (as is the case of the RPI) but also institutional households (corporate and businesses) and foreign visitors.
So for example the weighting of just 2.25 per cent for the “water, electricity gas and fuels” is clearly unrepresentative of our current spending pattern in 2008. Yet we continue to publish a faulty RPI which eventually sets the basis for COLA adjustments as if we are still in the year 2000.
On the contrary “transport and communications” has a weighting of 23.13 per cent. In all honesty do private households in 2008 spend 11 more times each year on transport and communication expenses (private car including maintenance and fuel and telecommunication bills) than they spend on their utility (water and electricity) bills and gas / kerosene consumption for cooking and heating?
It is evident why government, irrespective of social considerations, finds it much more convenient to recover higher energy cost by raising the surcharge on utility bills rather than the price of fuel at the pump. Due to the skewed weightings in the Household Budgetary Survey on which the RPI is calculated, increases in the price of fuel at the pump will have 11 times more impact on the RPI than increases in utility bills.
Beyond interpretation of the published figures there is often controversy on what is causing inflation. Is it imported higher prices of energy, commodities and food over which government has little control and which hopefully would be one-off in nature, or is it more to do with internal dynamics in price movements that are more within government’s sphere of influence, at least theoretically?
The correct answer is that it is both. Clearly 7.8 per cent in prices of food and 31.29 per cent in the prices of energy are imported stuff which government cannot do much about, unless we start forking out expensive subsidies which delays demand adjustments and break the public coffers. However there is some evidence that this first impact of imported inflation is partially seeping through second round price rises in other sectors. How can one explain a 7.02 per cent in clothing and footwear and 5.6 per cent increase in the price of educational services?
Nobody is suggesting that we return to across-the-board price controls to contain inflation. Furthermore in a monetary union we have pretty little tools left to use, as monetary policy is decided by the ECB for the whole union and fiscal policy has a fixed aim to balance the budget by 2010. What we are left with, is consumer education and effective consumer protection through price checks on regulated activities and dissemination of information so that consumers know with as little hassle as possible that they have a choice.
This is why I find the stiff increase in price of clothing and footwear, one of the most competitive sectors, hard to understand unless we have become all so choosy to have switched from generics to branded products.
Let me try to unravel this complex issue. Every month we get four different inflation readings. The inflation results published for July 2008 can be seen in the table above.
The main difference between the RPI and the HICP is that the latter captures also hotel accommodation prices normally consumed by tourists. This element is not included in the RPI. There are also some minor differences in classification and weighting adjustments, which however leave very negligible impact on the overall result.
So the fact the HICP measure is higher than the RPI measure for the 12 months to July 2008 is positive in the sense that it shows that the economy is enjoying a buoyant tourist season permitting our hotels to increase their room rates.
The 12 months moving average measure smoothens out changes as rather than measuring the increase of the Index from a point 12 months ago to the same point this year, it measures the average of the last 12 months this time last year to the same average of the last 12 months. Accordingly price movements are more instantly reflected in the 12 months measure and will take time to get reflected in the 12 months moving average method.
Probably the RPI 12-month inflation measure is closer to readers’ personal experience but I still do not blame anyone who feels that in their case the real inflation is higher than the 4.80 per cent declared by the statistics. This is because the RPI averages out consumption patterns as they result from a nationwide household budgetary survey and one’s personal consumption pattern could vary substantially from the average.
Let’s take food as an example. This has a weighting of 23.82 per cent in the measurement of the RPI. Now this percentage could be too much for high income persons and could be too little for low income earners. People have to eat every day and there is a limit to how much they can eat even if they are rich. So food consumption as a percentage of total expenditure tends to vary inversely with the level of income. The higher the income the less one spends on food in percentage terms and vice-versa.
Given that food showed a 7.80 per cent increase in the year to July 2008 it is quite understandable that low income earners probably feel that their cost of living has gone up more than reflected in the RPI. On the contrary “water electricity gas and fuels” which increased by 31.29 per cent in the 12 months to July 2008 have a much higher impact on richer consumers than the 2.25 per cent weighting given in the index.
This brings me to the third point. The RPI is based on a Household Budgetary Survey which was collected seven or eight years ago. The HICP on the other hand has a base year 2005 but the weightings are reviewed annually for changes in consumption pattern as resulting from the National Accounts and such consumption includes not only private households (as is the case of the RPI) but also institutional households (corporate and businesses) and foreign visitors.
So for example the weighting of just 2.25 per cent for the “water, electricity gas and fuels” is clearly unrepresentative of our current spending pattern in 2008. Yet we continue to publish a faulty RPI which eventually sets the basis for COLA adjustments as if we are still in the year 2000.
On the contrary “transport and communications” has a weighting of 23.13 per cent. In all honesty do private households in 2008 spend 11 more times each year on transport and communication expenses (private car including maintenance and fuel and telecommunication bills) than they spend on their utility (water and electricity) bills and gas / kerosene consumption for cooking and heating?
It is evident why government, irrespective of social considerations, finds it much more convenient to recover higher energy cost by raising the surcharge on utility bills rather than the price of fuel at the pump. Due to the skewed weightings in the Household Budgetary Survey on which the RPI is calculated, increases in the price of fuel at the pump will have 11 times more impact on the RPI than increases in utility bills.
Beyond interpretation of the published figures there is often controversy on what is causing inflation. Is it imported higher prices of energy, commodities and food over which government has little control and which hopefully would be one-off in nature, or is it more to do with internal dynamics in price movements that are more within government’s sphere of influence, at least theoretically?
The correct answer is that it is both. Clearly 7.8 per cent in prices of food and 31.29 per cent in the prices of energy are imported stuff which government cannot do much about, unless we start forking out expensive subsidies which delays demand adjustments and break the public coffers. However there is some evidence that this first impact of imported inflation is partially seeping through second round price rises in other sectors. How can one explain a 7.02 per cent in clothing and footwear and 5.6 per cent increase in the price of educational services?
Nobody is suggesting that we return to across-the-board price controls to contain inflation. Furthermore in a monetary union we have pretty little tools left to use, as monetary policy is decided by the ECB for the whole union and fiscal policy has a fixed aim to balance the budget by 2010. What we are left with, is consumer education and effective consumer protection through price checks on regulated activities and dissemination of information so that consumers know with as little hassle as possible that they have a choice.
This is why I find the stiff increase in price of clothing and footwear, one of the most competitive sectors, hard to understand unless we have become all so choosy to have switched from generics to branded products.
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