(Adapted from Business Times Online)
SOME of my friends are grumbling about the recent increases in food prices. Nasi lemak, capati and teh tarik are costing more these days. Inflation, inflation, inflation, they muttered - how could inflation be two per cent, they questioned, referring to the increase in the Consumer Price Index (CPI) provided by the Department of Statistics.
Before you know it, they start making guesstimates of what the real inflation rate is in the country. Blame it on us economists. We are the ones who never make people understand what we mean by "inflation" when we talk to the public. Economists are a group of people who speak like people from Mars. When we say "current account", we mean current account of a country's balance of payments and not the current account balance that you have in your personal bank.
When we say gross domestic product or GDP, we normally mean the value of a country's output after it is adjusted for inflation. Well, at a time when inflation is becoming such a hot topic in this country, it would be helpful if we could speak a layman language so as to make it easier for people to understand. Let me try. When people talk about inflation, they normally refer to price increases of the goods that they normally purchase. These would include prices of milk, eggs, fish, bread, rice and even costs of different types of services like haircut, transport and so forth.
Some of the prices of these products and services have arguably increased quite significantly in the past one year due to high transport cost (as a result of an increase in fuel prices) and commodity prices. So when prices of the products they normally buy rise by say, 10 per cent, they think inflation rate should also be at least 10 per cent. That's not how economists see things when it comes to inflation. The inflation rate - which is essentially derived from the changes in the CPI - is derived the following way. First, pick up a basket of goods and services that a typical family would spend their income on.
For Malaysians, this would mean food items like rice, bread, eggs and some other basic foodstuff as well as other common services that they have to pay for like transport and communication. Note that this basket should theoretically be based on the current spending habits of a typical family in Malaysia. It must not be confined only to a particular class of the population. In fact, it should reflect the general taste of the population. Second, put proper weightage, say 30 per cent on food items and 10 per cent on transport - meaning that 30 per cent of our expenses goes to food and 10 percent goes for transport cost. Then value that basket of goods and services over time and see their changes.
Okay, this is where a major problem arises. How in the world can we construct a basket that represents every family's expenses? What my family consumes is definitely different from what your family spends on. To add to that, should there be a significant income disparity between two families, the difference in consumption pattern will become more prominent. Rich people who spend more on imported products for example may not feel the impact of "inflation" if only prices of local goods rise. Lower income people who consume say, more fish than poultry may imagine that inflation is skyrocketing if prices of fish suddenly escalated. But for those who hardly purchase any fish, they do not feel such a phenomenon.
So what this means is that when an individual starts complaining about inflation, he normally refers to price increases in his own basket of goods and services - the things that they normally purchase over time. Not surprisingly, each person can have his own inflation rate which differs significantly from the inflation figure that economists normally say in newspapers or on television. Economists only refer to a general price increase of the basket of goods that is being used by the Department of Statistics, a basket that supposedly represents goods and services purchased by a typical family in Malaysia.
So should we just chuck this thing called CPI out of the window? Maybe not. Firstly, it is the least we can do to gauge the trend of prices in the economy. Other countries are doing the same thing using the CPI, although some countries like the US prefer to use other measures called the core personal consumption deflator. There is also a similar gauge called the GDP deflator. While it will be too lengthy to elaborate on these two alternative measures, the important point to note is that these so-called "deflators" do not measure prices based on any specific basket.
They are based on the actual goods and services that we purchase over a period. They are sometimes referred to as changing weight price indexes that cover all goods and services in the economy. Notwithstanding their usefulness, however, these measures have their own drawbacks, on which I do not wish to elaborate in this article. Secondly, using CPI, we can dig up more details about price trends because different breakdowns are given by the Department of Statistics. For instance, prices of food and non-alcoholic beverages have generally risen by 4.5 per cent in February this year, compared with 2.3 per cent in June last year. Other notable increases are alcoholic beverages and tobacco where prices climbed by nine per cent in February, compared with 4.7 per cent in the middle of last year.
But one important tip for consumers - it is advisable to look at trends rather than absolute numbers in order to get a feel of where price pressures are coming from. So, don't grumble when you hear economists say inflation rate is only two per cent. They are not pulling your leg. They are just referring to the increase in the value of the basket which is being used by the Department of Statistics. Admittedly, it will never be a perfect basket but it is the best that we have to reflect a typical consumption pattern of the population.
The writer is the chief economist at Malaysian Rating Corp Bhd.
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