Macro

At Yahoo, I write on Consumer Prices: A Better Inflation Indicator

"Inflation is when you pay Rs. 100 for the fifty rupee haircut you used to get for 25 rupees when you had hair"; a quote I received on twitter. In India, when we speak of inflation, we've never really talked about haircuts. No, I'm serious, stick with me.

The Inflation Index that our country talks about is based on the Wholesale Price Index (WPI), which is a weighted sum of product prices at the wholesale level. That means stuff that you can buy at wholesale markets, such as vegetables, copper, fuel, or even liquor. But it doesn't include the cost of services; the WPI will indicate the cost of vegetables and meat to your favourite restaurant, but it won't add up the cost of chef/waiters' salaries, rent of the premises, air-conditioning costs and valet parking. In the haircut example, they'll note that the scissors or shampoo got more expensive, not that the haircut costs you more.

The world over, what is used is a Consumer Price Index (CPI), which uses a basket of goods that you are more likely to consume and uses end-user prices (not wholesale). CPI is more indicative of inflation that the common man faces. India has taken uncoordinated steps in that direction, with the labour bureau releasing three monthly CPI numbers for Agricultural Labourers, Rural Labourers and Industrial Workers, and the Ministry Of Statistics and Programme Implementation (MOSPI) releasing the CPI for Urban Non Manual Employees (UNME).

Multiple Consumer Price Indexes were necessary, we were told, because the spending pattern of different people was different.

A few years back, MOSPI decided to halt collection of data for the UNME based CPI and prepared data collection for a new index called, with great creativity, the "New CPI". This contains:

With the base year as 2010, MOSPI has released data for every month in 2011. This index consists of rural and urban data, with different weights given to each sub-head. The New CPI is envisaged to clear all the confusion among the current CPI indexes; we can only hope that someone else comes up with a "Newer CPI" and confuse the bejeezus out of everyone.

So what has inflation has looked like, when it comes to consumer prices? Since the first data point in the New CPI is January 2011, our first real annual inflation point will be revealed with data for January 2012 (since inflation is a year-on-year change). But we could extrapolate, by looking at December data and comparing it to January.

CPI inflation, thus calculated, gives us an annualized figure of 8.2%. The WPI inflation — the newspaper version — is 7.5%. This is counter-intuitive — food prices are the ones that have reduced the most, and food is nearly half of the CPI. Comparatively, food has a far lower weight in the WPI.

What has happened, then? Let's look at the components:

While food has fallen, much of everything else — from fuel to housing to clothing — has gone up substantially more. If you remove food, the New CPI has gone up 11.4%!

(Even within food, it is vegetables that are down more than 25% from last year, when prices of essential vegetables were shooting through the roof. Take Veggies out and inflation goes to double digits)

In the US, they have a concept of "core" inflation, which is "non-food, non-fuel" — meaning, items that are not heavily volatile. If you calculate that with the WPI, it is only about 8%. But with consumer prices, "core"inflation is 10.70%, a significantly high number. At the core level, prices are sticky — that barber who raises his haircut prices isn't going to reduce it just because shampoo just got a little cheaper.

Think of it this way: when cost prices and salaries go up, barbers will suck up the cost initially. When they can't do it anymore, they'll raise haircut prices. Now even if costs go down, their wages will not decrease — who takes a pay cut voluntarily? — so the consumer's price remains constant. This is "sticky" inflation and one of the most difficult to reverse.

CPI measures inflation you can actually see. Rents are going up. Wages — not just yours but also those you hire, are shooting up. Clothes, restaurants, fuel — all up. The inflation that we saw in the wholesale prices a year or so back (inflation at the primary and wholesale level was nearly 20%) has now moved into items where you and I can feel the pinch.

Still, it's not useful to emulate what the west does. The US attempts to mask its CPI-based inflation by making adjustments that distort the CPI itself. It uses a substitution effect — stating, in effect, that if meat prices go up too much, people will substitute it with chicken, so we'll use the lower of the two prices. They use "hedonic adjustments" to show, for example, that a computer has become cheaper even if you pay the same price, because you get more hard disk space today. These are vaguely justifiable changes, but very wrong in the context of calculating how the common man hurts. While the objective of doing such a thing is unclear, most people believe they are used because they make GDP data look better. Luckily, our tinkering with four different CPIs has kept us from such adjustments.

The CPI is, in general, a better indicator of inflation than a wholesale price index; the rest of the world also thinks so. We have a new index, and let's hope they regulators decide to use it to gauge inflation as it really is, and that index creators don't get ideas to distort the index so that it makes other data more appealing in comparison. And to address the issues with the WPI data, let's also hope that CPI data is properly maintained and promptly updated.

Maybe I'll be able to keep my hair on, just for that haircut.