Pin that Pricks


By Monish Chhabra ǀ 10th March 2015

India’s Prime Minister Narendra Modi
Source: The New Indian Express

In January, the Indian prime minister wore a pinstripe suit to greet the US president in India. The gold stripes on the suit were in fact the PM’s full name – Narendra Damodardas Modi– embroidered repeatedly into the blue jacket.

In February, the same suit was auctioned away, along with 400 other gifts that PM Modi had received since becoming the prime minister.

Why the change of heart?

10 days before the auction, the state elections in Delhi saw an epic rout. Modi’s BJP was expected to win the majority in the 70-seat state. The final result:

    • 2-year old AAP won 67 seats

    • 64-year old BJP got 3 seats

    • 130-year old Congress got zero!

Democracy is a free market. Valuations can adjust rapidly. Sometimes they are a blessing – good riddance to the suit!

The euro has adjusted too and Europe feels blessed.

Since its peak a year ago, the euro has fallen by 25%. The money supply grew at 4% in February year-on-year and the unemployment is inching down.

The private sector loan growth in Europe seems to be turning positive. Both the household and the corporate sector seem to have put in a bottom.

Japan is also reaping rewards from weakening its currency.

For the first time in 17 years the GDP deflator in Japan was positive in 2014 – reported at 1.6% - indicating inflation. The last positive number was 0.6% in 1997.

GDP deflator is one of the measures of inflation. Prices are finally rising in Japan.

Do they actually check the price of every good to measure inflation?

Nope. It is impossible to measure every transaction or every price in the country. Like most economic data, inflation is calculated from samples.

Samples are surveyed at certain locations and at certain times. The statistics produced is then reported on a regional or country basis. This is a massively approximated, extrapolated, non-uniform, evolving, survey-biased estimate.

Yet the financial media routinely slices, parses and argues about the second decimal place of such estimates.

How is inflation reported?

Most common measure is the ‘consumer price index’ or CPI.

The goal of CPI is to measure the change in the price to maintain a constant lifestyle for an average family. The starting point is a representative basket of goods and services consumed by a typical household.

What goes into the basket and how much, is updated periodically. There are many categories – housing, food, transport, apparel, entertainment, medical, education etc. Weights are ascribed to each based on its share of consumption.

Thus the CPI basket isn’t constant over time. As consumption patterns change, new goods are added (e.g. smartphones) and older ones removed. The quality and quantity change. So do the weights.

Another measure of inflation is ‘producer price index’ or PPI. It measures inflation from a producer’s perspective – hence includes raw materials and semi-finished goods.

PPI is usually considered a leading indicator of CPI - producers pay higher prices and then pass it to the consumers. As consumer prices rise, we hear the chatter from the central banks – like in the US currently - about rising rates.

But CPI is too volatile. Policy makers need stable longer-term indicators of price-trend. They adjust the CPI for seasonal changes, supply shocks or one-off events. They also strip out food and energy (considered too volatile and erratic).

The result is the ‘seasonally adjusted core inflation’. Central banks tend to prefer this measure to gauge overheating.

Then what is GDP deflator?

GDP deflator – as the name suggest – deflates the GDP. The GDP measured is in nominal terms. It has to be converted to a real number, to see if the growth in the economy was real value-add or just higher prices. GDP deflator does that trick.

GDP deflator is a price index just like CPI. However, the basket for the GDP deflator includes only domestic goods and services. As it measures ‘gross domestic product’, imports are excluded, which are otherwise a part of the CPI basket.

Which inflation measure actually matters?

To an average individual, it is the wage inflation. If one’s income grows faster or at least keeps pace with other broader measures, he would be fine. If not, he is in trouble, regardless of the level of CPI.

Even as a nation, wage inflation is essential to sustain consumer price inflation. People have to be paid more in order for them to pay more and more for the goods.

In 2014, the wages in Japan grew at 1.8%. That was 1% less than the inflation – meaning the real wages fell. To an average worker, the uptick in inflation made him poorer. If that continues, the demand would fall and so would inflation.

Economics or politics –the nominal growth must have real legs.

Otherwise, the bubble of perception is pricked by the pin of reality.

This write-up is for informational purpose only. It may contain inputs from other sources, but represents only the author’s views and opinions. It is not an offer or solicitation for any service or product. It should not be relied upon, used or construed as recommendation or advice. This report has been prepared in good faith. No representation is made as to the accuracy of the information it contains, nor any commitment to update it.