Inflation Peaking: Is it a number crunching to deceive the public?

In the last few months, central banks around the world have been giving varying forecasts on when present inflationary pressures would be peaking. Such forecasts are simply statistical exercises without any precision and credibility. The Governor of the Central Bank of Sri Lanka (CBSL) also has been citing various peaks of inflation since August while the President also mentioned at a recent conference that the Central Bank had informed him of peaking inflation in October.

The interest in checking the inflation peak is due to the notion that inflation behaves in bubbles, i.e., rising, peaking and falling, during a period of time. Therefore, the trace of the inflation peak is considered as a good piece of news to central banks and political leaders because they can please the public with the rhetoric of falling inflation in the period ahead. However, whether the public believes them is a different matter as the public can feel the effects of inflation in real time living although the public is not conversant about the estimates of inflation and its peaking or bubble behavior. What matters to the public is whether prices rise causing increases in the cost of living as compared to their income levels.

According to the CBSL press release issued yesterday, year-on-year inflation recorded 66.0% in October from 69.8% reported in September, reversing its continued increasing trend observed since October 2021. This means that inflation has peaked in September. Some informal media reported this as inflation has accepted the defeat and turned back. Very soon, the CBSL Governor will have victorious talks with the media that disinflation path has commenced due to the prudent monetary policy tightening he implemented since 8^th April this year.

Therefore, the objective of this short article is to present the myth behind inflation peaking notion used by central banks in their monetary policy languages.

Measurement of Inflation

Inflation quoted in economic reports is the percentage increase in the Colombo Consumer Price Index (CCPI) in a particular month relative to the index in same month of the last year. This is called year-on-year (Y-o-Y) inflation. For example, the CCPI was 146.9 in October 2021 and 243.8 in October this year (see Table at the end). 

Therefore, the Y-o-Y inflation or the percentage increase in the CCPI in October this year is 66%. The comparative Y-o-Y inflation in September (i.e., from September 2021 to September 2022) was 69.8%. According to the CBSL press release, Y-o-Y inflation has been continuously rising from 7.6% in October 2021 to 69.8% in September 2022. Therefore, inflation has peaked in September and commenced falling in October.

What is CCPI?

CCPI is a measurement of household cost of living based on urban household monthly consumer expenditure in the Colombo District as surveyed in 2012/13. The consumer basket contains 392 items with total expenditure value of Rs. 60,364.74 at prices that prevailed in 2013 (base year).

Accordingly, the expenditure value of this basket is calculated monthly at prices prevailing in the respective month to detect the changes in the household cost of living. Price information is collected from 14 selected market centers located in Colombo.

Accordingly, the cost of living was Rs. 88,675.80 in October 2021 and Rs. 147,169.24 in October 2022. Therefore, the monthly cost of living in October 2022 has risen by 66% from the cost of living estimated in October 2021 at prices prevailing in that month (see Table at the end). This is percentage in cost of living is known as Y-o-Y inflation. Therefore, the movements of the estimated cost of living are primarily driven by consumer items that have a high share (or weight) in the total consumer expenditure. 

However, the movement of the cost of living is shown as an index by taking the base year consumer expenditure (i.e., Rs. 60,364.74 stated above) as 100. This index is known as CCPI. Accordingly, the cost of living in each month is indexed to same series beginning 100 in 2013. Therefore, the index point for the cost of living amounting to Rs. 147,169.24 in October 2022 is 243.8 (i.e., 147,169.24/60,364.74 x 100). Accordingly, the percentage change in the index is the same as the percentage change in the cost of living. This means that an anyone-point change in the CCPI represents a change of Rs. 603.65 in monthly cost of living on same basket that was consumed in 2012/13.

Therefore, when economic policy authorities make rosy comments on their policies based on current inflation numbers, they must bear in mind statistical exercises and biases behind the index numbers. Inflation peaking is a similar rosy comment.

Why inflation peaking in September 2022 is a statistical myth?

When looking at details of present economic crisis and responsive behaviors of market prices, the incidence of inflation falling to 66% in October from 69.8% in September is momentary and, therefore, policymaking authorities have no reason for declaration of a victory over the war against inflation (see C1) (see Table at the end). I cite the following facts to substantiate this statement.

1. The inflation 66% in October is only a marginal decline from September level due to base effect involved in the calculation. In fact, inflation is still at a soaring level with an annual increase of 97 index points which is the second highest reported in the CCPI series since 2013 so far.

2. Inflation on an annual average basis (i.e., the increase of the average CCPI for 12 months ending October 2022 from the average CCPI for previous 12 months) has continued to rise from 33.4% in September to 38.3% in October (see C2). The average inflation is more representative for the cost of living during a period rather than between two months whereas the base effect is largely neutralized. Therefore, inflation peaking based on the Y-o-Y inflation is only a statistical gimmick to satisfy central bankers.

3. The increase in the cost of living still runs at alarming levels.

• First, the increase from the CCPI point in December 2019 is 84.1% in October 2022 as compared to 24.5% reported in March 2022 (the month before the present Governor assumed duties) (see C2).

• Second, although there is a marginal decline of Rs. 543 in cost of living in October, which is negligible at current level of prices in general, the monthly cost of living of a household around Rs. 147,000 its monthly increases are excessive (see C3 and C4) when compared to business bankruptcies, economic contraction around 9%-10%, supply side disruptions and loss of employment confronted by households. Therefore, any sign of reversing the cost of living and inflation towards pre-crisis levels are not traceable.

• Third, the marginal decline in Y-o-Y inflation in October is due to a momentary ease of prices of few food items which have high weights in the CCPI and, therefore, is not a sustainable momentum in anticipation of adverse effects of new tax hikes and continued global inflationary pressures where any fiscal measures towards easing prices are not expected.

4. The concept of inflation peaking, despite statistical implications around the calculation of inflation, could be practical if a significant reduction in the cost of living is expected to be sustained in a fairly short period ahead. However, the present macroeconomic policy management system does not provide any hope for it as factors behind present inflationary pressures are not expected to be resolved soon.

• First, the supply side improvements are not expected due to the acute shortage of the foreign currency reserve at the CBSL and its inability to provide for much-needed imports. As a result, the projected contraction of the economy by 8%-10% in 2022 and the difficulty in recovery of the growth back to pre-crisis levels in years ahead will continue to fuel price pressures.

• Second, domestic prices cannot be reduced without a significant rate of appreciation of the currency to pre-crisis levels. However, given the country’s foreign debt default and business bankruptcies, there is no hope for a significant net inflow of foreign currency sufficient to appreciate the currency in the near future.

• Third, as the CBSL blindly follows the high interest rate policy pursued aggressively by central banks in developed market economies, domestic interest rates cannot be expected to come down in years to come. As high interest rates around 30% at present keep pushing the cost of production and prevent mobilization of productive resources and business risk-taking, price pressures cannot be expected to ease at any time in the near future. Therefore, monetary policy in the current context is only an unnecessary disturbance to the recovery of the economy and price stability.

• Fourth, according to the present CBSL Governor, prevailing high inflationary pressures are a direct result of excessive money printing by the former two Governors for the purchase of Treasury bills to fund the government. Such money printing by those two Governors from the beginning of January 2021 to 7 April 2022 (the date the present Governor assumed duties) is Rs. 1,124 bn. However, the present Governor has been continuing same form of money printing at an accelerated rate as shown by the increase of Rs. 571 bn net during his tenure of 206 days so far as on 31 October 2022. This accounts for nearly 51% of the money printing undertaken by the former two Governors. However, total printing operation without netting the pre-matured retirement of Treasury bills held by the CBSL is around Rs. 950 bn. Therefore, in his view of inflation hypothesis connected to money printing, the present level of inflation is not possible to come down due to the continued money printing by the present Governor.

• Fifth, inflationary/price pressures are largely a result of poor business confidence in the economy and governance system. As there are no signs of improvements in business confidence in years to come, given fiscal and monetary policy bottlenecks and unsettled governance system, prices cannot be expected to come down in order to ease inflation as predicted in inflation peaking hypothesis.

5. Central banks in developed market economies state that inflation peaking helps them to anchor inflation around central bank targets as people will tend to lower inflation expectations used in economic contracts and behaviours. However, this hypothesis does not have any validity in countries like Sri Lanka confronting with hyper-inflation. Further, even if inflation is falling, it is only a statistical result which meaningless to real life because prices continue to rise causing higher cost of living.

6. The concept of inflation used for monetary policy is the macroeconomic inflation defined as the increase in general price level due to demand-supply imbalances. Therefore, CCPI based inflation estimates are not appropriate for central banks to target or boast the prudence of the monetary policy. For example, the decline in the cost of living in October is not due to the responsiveness of relevant food items to the policy interest rates but it is an ad-hoc event. The government also can control prices of major food items and energy to reduce cost of living as usual which is not credit to the monetary policy for lowering inflation.

Concluding Remarks

In view of the facts presented in brief as above, the notion of inflation hiking in October as conveyed by the CBSL to the President is nothing, but a deceitful act committed by hiding the relevant facts behind the reality. Therefore, the CBSL has lost its policy advice credibility, amidst the failure of the monetary policy to revive the crisis-hit economy in terms of its statutory mandate. 

The failure of the monetary policy to bring Y-o-Y inflation back to 4%-6% target is very clear as prices of consumer items in the CCPI basket are not responsive to high interest rates on the demand side while prices will rise through the supply side due to the increased cost of production caused by such high interest rates. Therefore, if the CBSL Governor wishes to be public accountable in his price stability mandate, he must implement the monetary policy towards a target around a specific index point in the CCPI by abandoning the meaningless Y-o-Y inflation number 4%-6%.

Therefore, economic advisors of the government must study the subject and educate the public on their plans to recover the economy with the prices/cost of living reduced to pre-crisis levels rather than plans on the advice of the IMF to hike taxes on the collapsing private sector in order to bailout the government which is responsible for the present economic crisis. Otherwise, the recovery of the economy or reduction in inflation will not be feasible even in the next decade due to the lack of business confidence in the government.

 (This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

 

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published)