Prices
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Consumer price indices |
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Producer and wholesale prices |
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Consumer or private expenditure deflators |
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The composition of price indices |
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Export prices |
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Import prices |
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Terms of trade |
Consumer price indices
The consumer price index (CPI) is the indicator most people use to track inflation. The index is familiar and readily available, but not necessarily accurate. The British call it the retail price index (RPI), while the Germans prefer to call theirs the cost of living index.
Basket contents and weighting
CPIs measure the cost of a basket of goods and services purchased by the average household each month. The basket's composition and weighting are usually based on surveys of household or family expenditure habits.
Some indices cover "essentials" only. By careful selection a consumer price index can be dominated by subsidised commodities and those subject to official price controls. This is how some developing countries keep down their reported consumer price inflation. Most indices, however, cover a fairly full range of discretionary expenditure.
Weights are updated annually in Britain and France, but most countries change their weights only every 5 - 10 years. Taxes on expenditure and subsidies are included in CPIs; it would be difficult to exclude them. Other taxes such as those on incomes are excluded, as are savings, life assurance premiums and capital spending.
Prices are usually found by observation, perhaps of over 100,000 items each month. Collection points vary from six state capitals in Australia to over 100 urban centres in France and Germany.
The information is collected by surveys on a particular day so a price change late one month may not be caught in the index until the following month. Indeed, in the US, for example, prices of most goods and services other than food and fuel are collected monthly in the five largest geographic areas and every other month in the remaining 80 survey locations. In some other countries major surveys are conducted only every three months.
Housing
The British and Canadian indices exclude the cost of houses and capital repayments on home loans but include mortgage interest payments. As a result, if the government increases interest rates to squeeze inflationary pressures, the index rises automatically, which is exactly the opposite to the desired and underlying effect. The UK produces an index excluding mortgage interest payments to overcome this problem, which is used by the Bank of England to target inflation. Most other countries use a more satisfactory rental equivalent for measuring housing costs.
Producer and wholesale prices
Wholesale price indices (WPIs) cover prices charged at the first stage of bulk distribution and generally include import prices. WPIs were first introduced to measure prices of raw materials.
Producer price indices (PPIs) track prices of home produced goods at the factory gate. Most PPIs cover output prices of goods, although some countries also prepare input price indices for raw materials purchased by industry. In principle, input prices include transport to the factory and output prices are ex-works, although such prices cannot always be identified neatly.
PPIs shed light on cost pressures affecting domestic production and are more useful than WPIs. Most major countries now produce PPIs but Switzerland produces only a wholesale prices index, as do, for example, Austria, Greece and Norway. The indices cover manufacturing and, sometimes, agriculture (Belgium). But less developed countries rarely calculate either price measure.
Consumer or private expenditure deflators
Consumer expenditure or private consumption deflators are derived from current and constant price estimates of total consumer expenditure. This reflects actual spending which is arguably better than the consumer prices basket approach of outlays by an average family. It also avoids a selective approach when specifying what goes in the basket.
In addition, consumer prices data are collected at one point each month, while deflators relate to averages over the period, usually three months at a time. The deflators normally include an imputed figure for house rents, which is less distorting than the interest-rate approach used for the British RPI and the Canadian CPI.
However, deflators are not available as rapidly as consumer price indices and are revised more often. Movements in implicit price deflators reflect changes in the composition of consumers' expenditure as well as changes in prices (fixed-weight deflators avoid this problem). The personal sector is broader than households; it often also covers unincorporated businesses (such as farms, pension funds and trusts) and private non-profit bodies (such as charities and trade unions).
The composition of price indices
Most price indices are weighted averages of several prices. It is difficult to choose weights for some indicators, such as commodity price indices, although often the basis for the weighting is clear. If 20% of an average family's spending goes on food, food has a 20% weight in the index of consumer prices. This can cause problems for interpretation, since there may not be an average family. The average rate of inflation is not experienced by a newly married couple with spending dominated by mortgage payments, nor by a retired person with little expenditure on consumer durables. It also poses problems if spending patterns are changing over time.
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Base-weighted indices may be used to measure changes over any period. A good example is the US GDP fixed-weight price deflator which uses weights relating to 1992. The weights are the same for each year, so changes in the index reflect changes in prices only. The snag is that the weights may become outdated. |
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Implicit deflators reflect changes in prices and spending patterns. For example, the US GDP implicit price deflator measures the difference between current and constant price GDP. Since the weights reflect the composition of GDP in each period, changes in the index reflect movements in both prices and the composition of GDP. |
Average values
Export price indices, including the deflators released with GDP data, capture changes in both the prices and the composition of a country's external trade.
Unit values
Indices of export unit values, which are essentially fixed-weight price indices, highlight changes in prices only. This is useful for reviewing cost and competitive pressures. However, since the weights get out of date when the structure of trade changes - as it inevitably does - unit value indices are best for analysing short-term trends.
Compare export price indices with domestic price indicators, such as the producer price index for home produced goods, to get a feel for the way that manufacturers are passing on cost pressures to foreign buyers; or perhaps being constrained from doing so by international competitive pressures. On WorldData export prices are given in dollar terms to aid international comparison, so before comparing the figures to consumer prices, the export price data must be converted back to local currency.
Average values
Import price indices, including the deflators released with GDP data, capture changes in both the prices and the composition of a country's external trade.
Unit values
Indices of import unit values, which are essentially fixed-weight price indices, highlight changes in prices only. This is useful for reviewing cost and competitive pressures. However, since the weights get out of date when the structure of trade changes - as it inevitably does - unit value indices are best for analysing short-term trends.
Use import price indices to judge external cost pressures. Import prices that are rising faster than domestic prices are a clear warning of imported inflation. On WorldData import prices are given in dollar terms to aid international comparison, so before comparing the figures to domestic prices, the import price data must be converted back to local currency.
Terms of trade
The terms of trade indicate the purchasing power of a country's exports in terms of the imports that they will buy.
Favourable or unfavourable
The terms of trade are said to improve if export prices rise more rapidly or fall more slowly than import prices. For example, if export prices rise by 5% and import prices rise by 2%, a given volume of exports buys roughly 3% more imports; the terms of trade have improved by 3%.
Common terminology suggests that movements in the terms of trade are "favourable" or "unfavourable". However, after an "unfavourable" movement in the terms of trade, the trade balance will tend to improve (the smaller rise in export prices than import prices means that exports are more competitive), while a "favourable" movement in the terms of trade may price exporters out of the market and result in a weaker trade balance.
Which way is up?
Governments usually define the terms of trade as export prices divided by import prices expressed in index form. A rise in the index indicates an improvement in the terms of trade - one unit of exports will buy more imports.
Related topics:
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Index numbers |