Full gamut of inflation dynamics hidden by relatively stable headline inflation
The latest reading on the Namibia Consumer Price Index was released earlier this week, clearly showing a continuing trend of very stable so-called headline inflation. But this can be very misleading as there are various factors to consider when expressing the increase or decrease in prices in percentages. Although somewhat technical, it is important to understand the trends in inflation, especially if one wants to construct an inflation outlook for the rest of the year.
The Namibian Statistics Agency goes out of its way to make a very clear distinction between annual and monthly inflation, and further between such concepts as average annual and year to date inflation. To the layman these distinctions are confusing, obfuscating the basic fact that inflation expresses a change in prices over a given time. These intervals are not discretionary and they are chosen intentionally to conform to the conventional time cycles in the broader economy, i.e. months, calendar years, 12-month periods, and year to date.
While it is technically correct to refer to annual inflation for a particular month, in this case April, it must be remembered that this is only relevant as a comparison to April last year. The agency is 100% correct to say that inflation continued its downward trend because their annual inflation measure is a monthly measure compared to the same month, 12 months ago. In this case it is obvious that 3.6%, the latest reading for April is less than the 6.7% for April last year. The same methodology applies to every single month of the year, so for January, February and March, the three consecutive 3.5% readings are indeed a sign of a continued slowdown in inflation because the comparative reading for January, February and March last year, were 8.2%, 7.8% and 7% respectively. Remember these are all based on an underlying index which does not measure percentages but index points.
But the conventional way of expressing annual inflation fails to indicate the trend and that is where the concept relative inflation as opposed to nominal inflation comes in. On the surface, it seems inflation has been stable for the first four months of this year. Al least that is how it looks to most non-technical people, that is why we get a concept like headline inflation.
Headline inflation does not exist in formal statistics. It is a creation of the business press and it works well to convey the bigger inflation picture to an ordinary readership. It is the measure of inflation that is quoted most often, and it is simply the monthly (progressive) annual reading taken as if that is the inflation right now. It does not say anything about the incremental inflation from one month to the next, neither about average annual inflation, nor about inflation year to date. It is also an overall picture, or a representation of price movements as they apply to all the items in the basket.
Simply to say inflation continues to slow down because the monthly readings are less than the comparative monthly readings last year does not suffice. To make this clearer we need yet another concept and that is relative inflation. This is also the reason why the statistics agency compiles the basic price movements in an index and only calculated the percentages afterwards. It avoids all the complexities of relative inflation.
This is an expression of the rate of change in inflation or the so-called Delta. Let me explain this by using the first four months of this year as an example. Annual inflation in January was 3.5%. But this is a percentage based on the January 2017 reading which in itself is a percentage of January 2016. Do you see where this is going. Every month’s annual inflation reading is an expression of a previous variable 12 months earlier, carrying on up to 2010 when the index was rebased. This is highly confusing and conceals the real value of inflation statistics where companies use them to adjust their own pricing, and to negotiate annual increments with their staff.
If we apply relative inflation to the monthly readings, it is easiest to understand when expressed as coefficients. Without going too deep into technicalities, let me state that annual inflation from January 2017 to January 2018, expressed as a coefficient, is 0.287, for February it is 0.273, for March 0.245 and for April 0.241. This is merely a way of calculating percentages of percentages but it works well to identify a trend. What it also does is to support in a more tangible way the statistics agency’s notion that “inflation continues to come down.” (The coefficient gets smaller and smaller.)
But here is the real kicker in terms of the analytical value of relative inflation. When you reverse the calculation you will see that the Delta between January and February is 4.88%, between January and March 14.63% and between January and April a not-insignificant 16%. This is a substantial reduction in inflation, not only compared to last year, but also year to date.
It is only relative inflation that allows the analyst to show this trend in a way that it makes sense, or is digestible to the lay user. In plain simple language, it means that the effective April inflation is 16% less than the January inflation, and even more compared to last year.
If this is too complicated for the average reader, then you will understand why the concept of headline inflation has been created. This is fine as long as you remember this simple take on inflation is somewhat misleading. Inflation has not stabilised as it seems on the surface, it continues to decelerate but at a faster actual rate than the equally simple 12 month comparison. Delta should stabilise in July because that is when annual inflation first stabilised last year.
It bodes well for the economy in general. It will bring relief to household expenses quicker than anticipated, and in our context, consumer spending is an important part of what drives the bigger economy.