This article is a
continuation of last week’s article which seeks to define and explain some
basic key terminologies often used by monetary and fiscal authorities. Various
indicators are used to measure the economic and financial sector performance of
an economy and understanding these key indicators is of paramount importance to
the public.
Today’s article will
focus on one of the most used indicators of economic and financial performance
which is inflation.
Inflation defined:
In the field of economics,
inflation is defined as a general increase in the price level of goods and
services in an economy over a period. The general increase or rise in prices
results in each unit of currency buying fewer goods and services and therefore,
inflation reflects a reduction in the purchasing power per unit of money – a
loss of real value in the medium of exchange and unit of account within the
economy. On the other hand, we have what is called deflation, which is the
opposite of inflation, which is defined as a sustained decrease in the general
price level of goods and services.
Measurement of Inflation
The common measure of inflation is the inflation rate, which is the annualized percentage change in a general price index. Price indices are used to measure the relative price changes of goods and services in a region (generally a country) during a specific period (e.g., financial year, or quarter, or month) and we do have a variety of the price indices which will later be explained in this article. Using the price indices, we measure how much the price of goods and services have increased (Inflation) or decreased (deflation) from a fixed normal year, known as the base year, and with respect to this base year, a calculation is made on how much increase or decrease in prices happened in this current year. Generally, the price indices are used to measure the cost of living to determine salaries or wages necessary to maintain a constant standard of living.
The different Price Indices
Goods and services are provided to the consumer by the producer and such the various price indices are calculated depending on the various stages/levels i.e. either at producer level (PPI), wholesale level (WPI), and retail/consumer level (at the retail market, from where consumers buy) – CPI.
Producer Price Index (PPI)
A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output. PPI is used to track pure price changes at the producer level for goods as well as services.
Wholesale Price Index (WPI)
WPI is used to track the prices of goods at the wholesale stage (i.e., goods sold in bulk, rather than retailed), and traded between organizations, before being forwarded to consumers. It is impossible to calculate price changes of all the goods traded in an economy, and therefore it is logical to take a sample set, or 'basket of goods to measure the inflation of a few important goods/commodities to determine the price changes in relation to a base year. WPI indicator tracks the price movement of each commodity individually, and then determine through the averaging principle employing techniques or methods such as the Laspeyres formula, Ten-day Price Index, etc.
Consumer Price Index (CPI)
While WPI is calculated in the
wholesale stage, CPI is determined at the retail stage, where consumers are
directly involved. Hence, the CPI method better measures the effect of
inflation on the public. CPI measures changes in prices, paid by consumers for
a basket of goods like WPI, but in this case using retail goods, instead of
wholesale goods. It is important to note that these
goods/commodities can be classified as primary goods (food, non-food, minerals,
fuel, and power, and manufactured goods, and then their weighted average can
then be taken to measure CPI.
For example, the RBZ always reports
headline inflation and core inflation. Headline inflation is a
measure of the total inflation within an economy, including commodities such as
food and energy prices (e.g., oil and gas), which tend to be much more volatile
and prone to inflationary spikes. On the other hand, "core
inflation" (also non-food-manufacturing or underlying
inflation) is calculated from a consumer price index minus the volatile
food and energy components. Headline inflation may not present an accurate
picture of an economy's inflationary trend since sector-specific inflationary
spikes are unlikely to persist.
Author: Tillas Gopoza is an Economist. He writes in
his capacity as the Chief Economist for the Bankers Association of Zimbabwe. He
can be contacted at tillas@baz.org.zw