Point of View: Less obvious than they seem

Lower average inflation in SA is surely welcome – but will it make doing business or consumption less risky? The benefits of lower inflation in SA may well be less obvious than they seem.

The average price that SA consumers paid for goods and services actually fell by 0.2% in January. The Consumer Price Index (CPI) measured 110.8 in January compared to a level of 111 reached in December 2014 (based on December 2012 = 100). The CPI first reached the level of 111 in August 2014 and is now lower than it was five months ago. Thus headline inflation, calculated as the year on year change in the CPI, has fallen away sharply and, if present trends in the CPI were to continue (which is unlikely) , inflation in a year would be below 2%.

The CPI is but an indicator of the average prices paid by the average SA household for a fixed representative basket of goods, as pre-determined by Stats SA based on its surveys of household spending patterns. As we are all well aware, any average can hide a large dispersion about the mean. The old saw about feet in the fridge and head in the oven yielding a moderate average bodily temperature makes the point. Some of the goods and services included in the CPI may be rising at a much faster rate than others – some important items may even be falling, helping to reduce the CPI and the average inflation rate. This has been the case over the past 12 months.

The different components of the household budget have realised very different inflation rates. The average price increased by 4.4% since January 2014. Food and non-alcoholic beverages, with a large weight in the average budget of 15.41%, rose by an above average 6.5% over the past 12 months. Inside the food trolley, dairy products, milk, eggs and cheese rose by as much as 12.1% year on year. The goods helping to hold down average inflation in 2014 were petrol, with a 5.6% weight, was down 17.6% over the 12 months, while the prices of so called private transport, with a weight of 7.25%, fell by 13%. Telecommunication equipment, presumably high quality or computer power adjusted, was estimated to have fallen by 12.1% in 12 months.

While the quality adjusted prices charged for cell phones and the like may well fall further, the chances of fuel prices declining further seems remote – since even if the rand price of a barrel of oil were to decline further, National Treasury is bound to levy a higher excise tax on petrol and diesel.

Clearly the all important relative prices – the price of food relative to the price of transport – changed quite dramatically and can be expected to continue to do so. Businesses have to be constantly aware of the changing relationship between the prices of the goods and services they buy, including labour services, and the prices they are able to charge in their market places and adjust accordingly.

Presumably households consume more of the relatively cheaper goods and less of the more expensive stuff. They may well trade down – that is sacrifice quality for price as goods or services become relatively more expensive. Stats SA only periodically (every five years or so) adjusts its CPI trolley of goods and services for such shifts – that may be influenced by price as well as by innovations on the supply side of the economy.

Another way of measuring prices is through the use of deflators, as used in the National Income Accounts to convert the value added in money of the day prices to their real equivalent. A deflator takes current consumption or expenditure patterns and converts them into their constant price equivalents. In other words, it calculates what the goods and services bought today would have cost in some base year. Changes in this deflator then offer an alternative view of inflation.

A comparison between the Household Consumption Goods Deflator and the CPI, based on 2010 prices as well as the respective inflation rates, is shown below. The trends are similar but not identical.

Using the deflators can demonstrate just how much relative prices have changed in SA over the years. Deflators are available for a large number of items included in total household consumption. The deflators for the main categories – household spending; non-durable goods, mainly food and beverages; semi durables, mainly clothes and footwear; durables, namely vehicles, furniture and appliances; and household services, utilities, restaurants, entertainment and domestic service – are shown below and are based on 1990 prices for purposes of comparison. As may be seen, the prices of food and services have increased at a much faster rate than the prices of semi-durable and durable consumer goods. Food prices have increased by over seven times since 1990 and clothes and footwear by only two times, with services increasing at almost the same rate as non-durables. We also demonstrate how much more relatively expensive food and services have become.

A large part of the theoretical case made for low rates of inflation is that low inflation helps stabilise relative prices. Such greater certainty about relative prices – or the relationship between the prices of the goods and services we sell and those we buy – would be helpful to producers and consumers. It would help to reduce uncertainty about relative prices and so reduce the risks of undertaking consumption and production over time, which would thus be to the advantage of economic growth.

Unfortunately there is no evidence that lower consumer goods inflation in SA has in any way reduced the dispersion of the prices of goods and services consumed by households about their average. According to the deflators, the rates of inflation of the many goods and services consumed by households differ now by as much as they ever have, as we show below.