The inflation rate is only 1.9% if ...

by **Cals** Mon 21 Oct 2013, 08:07

Posted on 21 October 2013 - 05:40am

COMMENT
By Pong Teng Siew

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THE accuracy of officially published rates of inflation in economies worldwide has been the bone of contention for consumers worldwide.

These rates are being used as the basis for calibrating interest rates, which lies at the core of central bank monetary policy that affects everyone of us. However, they may be so far removed from the actual pace of price increases experienced by most consumers that they have become the butt of jokes.

Worse still, these rates have effectively become the main pro-growth central banker's tool to effectively transfer wealth from savers to borrowers whose spending more directly boosts gross domestic product (GDP).

With Keynesian-inspired public sector spending profligacy spiralling out of control because of a perceived need to counter the demand deficit across so many economies worldwide in recent years, the biggest borrowers have been governments worldwide, and governments therefore have a vested interest in keeping interest rates low, or at least lower than they ought to be.

It is no wonder that many pensioners run out of money soon after they retire. The returns from their contributions to pension funds, being mainly invested in government bonds as required by statute, are low.

Monetary policy remains "accommodative" just about forever.

There are no longer interest rate cycles that respond to changes in the pace of inflation. Instead, there are levels that are kept quasi-permanently low in order to accommodate the perennial need for GDP growth to be above the rate they would naturally settle down to without governments' ceaseless rounds of stimulus and loans packages at concessionary rates or without central banks' intervention in the market.

Any spike in inflation rates, leading to step-like increases in price levels are quickly dismissed as transitory and are ignored, but intervening periods of stability are quickly seized upon as justification for not raising interest rates.

The ostensible justification for interest rates being kept low is, therefore, that inflation rates are low most of the time.

Are they indeed so?

My colleague laments that the ubiquitous nasi lemak vendors in the vicinity of the office have raised the price of their morning staple by 20 sen per packet in response to the 20 sen per litre rise in the pump price of RON95 petrol. That puts it clear into a double-digit percentage price increase.

Rather than seeing them as having opportunistically raised prices, I suggest that nasi lemak vendors have themselves faced a fairly extended spell of cost-of-living increases without being able to earn any higher an income.

Consequent to the petrol price hike, they merely figured that consumers would be more accepting of a price increase.

After all, our favourite nasi lemak vendor too has to own a house, foot the cost of repairs to his van, send his children to school etc and the cost of all these has progressively risen since he last increased the price of his nasi lemak.

So what is the real rate of inflation? It certainly feels like it is more than the 1.9% year-on-year stated as the average pace of price increase for the average consumer. The fault actually lies in the manner the index that supposedly represents the consumer spending basket is constructed.

As an example, years ago, few people owned a mobile phone, let alone a smartphone. Consequently, spending on communications did not even feature in Malaysia's Consumer Price Index (CPI).

Only beginning 2005 did the Malaysian CPI begin to reflect this change in the consumer spending basket, with first a 5.1% weight, then a 5.7% weight in 2010.

The consequence of this enlarging of items in the spending basket is that consumers are implicitly assumed to have reduced their spending on other traditional spending categories like food and transport.

In fact, consumers are more likely to have just spent the same amount as they had before on food and transport, and merely accommodated the new spending on communications by simply reducing their savings rate.

The unintended effect of this change is that food will feature a smaller share of the consumer spending basket and the CPI will then become less responsive to changes in the price of our favourite nasi lemak than before.

And while competitive forces have kept the cost of phone calls in a declining trend, with an accompanying drop in the associated CPI category index, consumers have kept rapidly increasing the allocation of their spending to communications by way of purchases of newer and more sophisticated gadgets and data plans.

In the US, the Bureau of Labor Statistics (BLS) has taken it one step further. Qualitative improvements such as computing power of personal computers are treated in their computation of the CPI as a decline in price.

A RM2,000 Intel Core i5 notebook in 2013 clearly offers far greater computing power than a RM2,000 Intel 8088 laptop back in the mid-1980s.

The BLS accounts for this in the basket of consumer spending as an exponential drop in the price of computers although it has no impact on how much a consumer will spend when purchasing a notebook.

Incongruently therefore, even if the US Federal Reserve were not locked in its current dogmatic pursuit of quantitative easing, it will not tailor interest rates according an inflation rate that reflects the true pressure from prices consumers pay at the cash till.

The issue of price level changes locally is about to take centre stage with the array of tax increases/subsidy rationalisation and revenue-raising measures that the government can be expected to install as part of Budget 2014 that will be tabled later this week.

Again, the effect of these increases on consumer level prices will surely be dismissed as transitory and a monetary policy response will be deemed inappropriate. The growth objective will remain imperative.

In the meantime, pensioners must tighten their already stiflingly tight belts further as they cannot expect any more returns from their savings than before in response to this looming generalised price level jump.

Pong Teng Siew is head of Inter-Pacific Research Sdn Bhd.
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