Why consumer inflation feels higher than it is

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NO ECONOMIC statistic attracts as much interest as the monthly consumer price index (CPI). This is partly because many other important economic measures are understandable only to economists.

Moreover, there is little evidence from their daily lives individuals can use to assess how accurate most other national statistics are. We may borrow money or buy imported products, but have no way to judge the accuracy of the gross measures of money supply or national imports to which our actions contributed.

In contrast, we all focus intensely on price changes of the consumer goods that make up the monthly measure of consumer price inflation. We are painfully aware of paying more for the same basket of goods we buy monthly. Invariably, we judge these prices to be rising much more rapidly than the CPI suggests. Why is this?

One reason is we tend to focus more on bad news than good. For example, we are more conscious of large rises in electricity and petrol prices than we are of much lower price increases in footwear and clothing.

Often we compare price increases over a much longer time period than the 12-month change used for CPI. For example, we may compare the petrol price with what we paid two years ago, forgetting that consumer inflation would also be much higher if measured over a similar period. A further complication is that the basket of goods we buy each month may not be the same as the one Statistics South Africa (Stats SA) uses to calculate inflation.

The basket of goods measured by Stats South Africa is weighted according to national spending patterns revealed in a survey. Our personal basket may not be the same as this. We may spend a larger proportion of our income on goods whose prices are rising fastest, in which case our personal inflation rate is higher than the CPI. But it is also possible we spend less on such goods and have lower personal inflation.

Stats SA attempts to provide for differences in consumption patterns by measuring inflation for different income groups. Over time, these measures do not vary hugely. From 2008 to December last year, the cumulative increase in consumer prices for the lowest income group was 31.9% and for the highest income group it was 25.2% — a difference of just more than one percentage point a year.

The cumulative difference in the prices of individual categories of consumer goods is often much larger than this. From 2008 to December last year, the largest cumulative price increase measured by Stats SA was 44.4% — for education. The smallest change was for communication, where prices fell 3.2% because the cost of telecommunication equipment fell 60%.

Varying rates of change in the prices of what we buy alter the proportion of our income we spend on different products. Tastes also change, and new items go into our basket of purchases. To cope with these changes, Stats SA adjusts the selection of goods whose prices are measured and their weightings to reflect current patterns. The latest adjustment, in January’s CPI, was based on a survey of household spending patterns conducted in 2011.

The new basket increased weightings for housing, education, restaurants and hotels and reduced the weightings for food and beverages, transport and communication. Changes as a result of new weightings are never applied retrospectively, as this would invalidate contracts adjusted by consumer price inflation in the past.

Improvements have also been made to the method of collecting and calculating the prices of certain goods. Changes to the weightings will now occur every three years to reflect shifting spending patterns.

These changes are important, as CPI is vital. Most annual wage adjustments are based on consumer inflation. South Africa also follows a system of inflation targeting, which obliges the Reserve Bank to keep consumer inflation at 3%-6%.

In 2003, Stats SA made an error in its calculations of housing rentals, which resulted in consumer inflation being overstated by two percentage points. This probably caused an unnecessary delay in the Bank’s decision to cut interest rates and weakened the economy. When the error was uncovered by a private sector economist, it was quickly corrected and interest rates were cut.

Most economists agree that the CPI is usually accurate. Its accuracy is supported by other data. It may not exactly reflect our personal experiences of price increases, but it is probably much closer to the national reality than we think.

By Gavin Keeton

Keeton is with the economics department at Rhodes University.

Source: Business Day



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