EKIP– Expert Club for Economics and Politics A Different Opinion
Very soon, the NSI released inflation data for 2013, which were interpreted on BNT the same day as follows: “We recorded the lowest annual inflation in 23 years. According to the National Statistics Office, this is a deflation of 1.6 percent.” [1] It turns out that the data is for December compared to December 2012; i.e. the average annual inflation was 0.4% and in practice we have a small “inflation.” [2]
According to these data, in 2013 we should be able to purchase almost half a percent fewer goods and services (on average per year) than in the previous year. It seems appropriate to shed some light on what “inflation” and “deflation” are and whether we are really getting poorer with each passing year.
When analyzing NSI or Eurostat data, it is important to be very careful about the definition of the concepts they use. The definition used on the European statistics website is: “ General price increase: In a market economy, the prices of goods and services can always change. Some increase, others decrease. We speak of inflation if there is a general increase in the prices of goods and services, and not just individual products. So a person can buy less with one euro. In other words, the value of the euro is less than before.” [3]
Although this idea is taught to economics students in college, it is completely wrong. Inflation is an increase in the volume of money in an economy relative to the goods and services in it. The consequence of this, ceteris paribus, is an increase in the prices of some goods and services because the value of money has decreased relative to them. In this line of thought, inflation is a monetary phenomenon, not a price phenomenon. Moreover, not all economic agents feel the higher prices to the same extent and at the same time. The first owners of the new money consume at the old prices. It takes time before the rest feel that the money in circulation has increased.
Not only do different economic agents experience the effects of inflation to different degrees – the prices of goods increase differently, and may not change at all or even fall. The first prices to rise are the prices of those goods for which the newly printed fiat money is spent. This is due to increased demand. Thus, those who have access to them first benefit at the expense of everyone else. The more money circulates in the economy, the more the number of goods and services whose prices increase (assuming that people buy different things). Accordingly, each subsequent holder of fiat money faces even higher prices.
This classic scenario of creating inflation – by printing money – cannot be realized in practice in Bulgaria. The currency board system prevents the government from printing money at its discretion. The only case in which the BNB is obliged to issue is in international trade. Then, in exchange for the new money, it receives euros in its reserve, which are exchanged for levs at a fixed rate. In this situation, inflation could occur if the purchasing power of the euro has decreased.
Now that it is clear that the statistical institute does not measure inflation, let's see what methodology is used to calculate what they define as "inflation". This is done by comparing the prices of goods in the base year with the future period. For this purpose, the so-called "consumer price index" is used. It covers various goods and services, grouped into "consumer baskets" - a large one (containing 665 goods for 2013) and a small one, including essential goods. When interpreting the NSI data on "inflation", we talk about the data from the large basket, because it is assumed that it includes the products that "normal" people (i.e. not the extremely poor, according to statisticians) consume. Once determined, the "contents" of the baskets remain unchanged for the entire period of the study.
It is worth paying close attention to. First of all, the “consumer price index” is not an economic indicator. It is a statistical average created by mathematicians for easier calculations. As such, the index is a highly inaccurate way of demonstrating changes in the prices of goods and services.
When statisticians group prices into “baskets,” what is not taken into account is that the prices of different goods change differently. For example, if we have a basket that includes two goods with the same price and the price of one of them doubles and the price of the other falls by half, the statisticians at the National Statistics Institute will report “inflation” of 50% for the month (or year). Judging by the interpretation of last week’s data, individuals will report that they are “poorer by 50%,” even though they will be able to buy a larger volume of the second good at the same price as before. Since such results can be obtained from only two goods, imagine what distortions in the final result are obtained with 665.
Another problem with the “consumer price index” and the use of fixed “baskets” of goods and services is that they do not measure how much is actually consumed. Statisticians can report that the price of a particular good is rising (which to them would mean greater “inflation”), even if very few people or none of them consume it. It also fails to take into account the fact that many goods are not technologically the same from the beginning of the study to the end. While a bushel of grain always contains the same content of almost the same grain, this is not true for things like black and white appliances. From the NSI’s point of view, a new model of phone or computer that allows us to do our work better and faster, but which is at a higher price, makes us “poorer”, even though it saves us time and effort.
Individuals do not allocate the same amount of income to this. For household X with a total monthly income of 10,000 leva, all other things being equal, the share of electricity costs will be relatively smaller than the share of the same share for household Y, which earns 1,000 leva. On the other hand, the members of X may consume more luxury goods or save more [4]. But whatever they decide to do with their money, changes in the price of electricity will have a smaller relative share for them than for Y. The data on “average annual “inflation” of 0.9%” has no bearing on the individual consumption of different households – for X the increase in the price of electricity will be smaller relative to their monthly income than for Y. Thus, the nominal 0.9% would have a greater weight for households with a lower monthly income than for those with a higher one.
In addition, people consume different goods and services. There is hardly a single household that has purchased all 665 goods included in the large “basket” during the year. Vegans are unlikely to feel affected if the NSI reports “inflation” due to higher prices for meat and dairy products. With this in mind, we must again note that the “average household”, on the basis of which the index is built, has little in common with real households and their different consumption.
The “consumer price index” is completely irrelevant to reality now. Even if we abstract from all the imperfections of the definition that statisticians use, the measurement mechanism only gives us an idea of a past period of time (in this case, the past 2013). It does not tell us whether we can currently buy more or less goods compared to yesterday, last month, last year... But it is not necessary - it is quite enough to go to the store to see if prices have undergone a correction. This is also true in cases where the central bank of country X has decided to print new fiat money to put into circulation. In this scenario, it is not the statistical index that serves as an indication of the new “money” - economic agents understand it through their interaction with each other, and statisticians calculating “inflation” only take this into account post facto.
The NSI’s data on “inflation” during the year is perhaps the most inaccurate measure of whether a unit of money can buy more goods and services than in a given past period or less. One of the very great skeptics of mathematical manipulations of information in economics (i.e., statistics), Ludwig von Mises, wrote back in the mid-20th century: “The common-sense housewife knows much more about price changes than statistical averages.” [5] The statistical “consumer price index” is such an imprecise quantity that its only application could be as an intellectual exercise in mathematics, the results of which have nothing to do with reality. Whether we are “richer” or “poorer” compared to last month or last year is determined by our personal income, our individual consumption, and the changes in the prices of the goods and services we consume, not by the statistical average that the NSI calculates and publishes every month.
[2] "The Harmonized Index of Consumer Prices for December 2013 compared to November 2013 is 100.4%, i.e. the monthly inflation is 0.4%. The annual inflation for December 2013 compared to December 2012 is minus 0.9% (Table 2 of the appendix). The average annual inflation for the period January - December 2013 compared to the period January - December 2012 is 0.4%.". From "Inflation and Consumer Price Index for December 2013", NSI
[4] Even if household X consumes more luxury goods, this does not matter to the index, because these types of goods are not included in its calculation.
[5] Ludwig von Mises, Human Action, pp. 23-24
Hello Mr. Vassilev,
The article started well by pointing out the difference between inflation/deflation and price changes. From there, however, you pleasantly surprised me with the quality of your article, so I decided to take a moment and make some corrections:
#1 Your entire argument from here on is based on a complete misunderstanding of what statistics are. I am convinced that no self-respecting statistician would tell you that you can take statistical data and apply it to any household that is included in the statistics. Such an operation has nothing to do with statistics and can only be the product of a person who has no concept of this science.
#2 Of course, averages always hide differences in their individual components. That is why the index is not presented as a single number, but is broken down based on important, fundamental differences in products, so that the veil of averaging can be lifted to a point where it makes sense from the point of view of the index. If you are interested in the price of an individual product, of course you do not need this index. Moreover, it would be absolutely wrong to apply the average inflation to the price of that product. This is the mistake of #1 applied to products, not to households.
#3 The index is weighted, i.e. the consumed volumes of the different products are measured and the index is calculated according to them. You could see this clearly if you had familiarized yourself with the documents "Methodology" and "Consumer Basket" from the NSI website - http://www.nsi.bg/bg/content/2506/%D0%B8%D0%BD%D0%B4%D0%B5%D0%BA%D1%81%D0%B8-%D0%BD%D0%B0-%D0%BF%D0%BE%D1%82%D1%80%D0%B5%D0%B1%D0%B8%D1%82%D0%B5%D0%BB%D1%81%D0%BA%D0%B8%D1%82%D0%B5-%D1%86%D0%B5%D0%BD%D0%B8-%D0%B8%D0%BF%D1%86. It takes exactly five minutes.
#4 Regarding changes in product quality (the example with the phone), the NSI is aware of this and is working on the issue "Treating changes in quality is one of the areas that the NSI has been working on in recent years." You can read more in the documents I mentioned.
#5 Of course, the index only applies to the past, otherwise it would be Vanga 🙂 I highly doubt anyone would claim that it applies to the future or the exact current moment. But still, information about the past is necessary and valuable to us in principle, precisely so that we have a better chance of predicting the future.
#6 In view of the above, the NSI data are far from being such a bad indicator of whether we can buy more or less with a unit of money. AVERAGE. Applying it to an individual household would be a fundamental mistake and the purpose of the index is not that at all, but to provide information to economists like you about general trends. It does a decent job of this task, but knowledge of statistics cannot be intuitive. Human intuition about statistical data is in most cases wrong. So it is the duty of every economist who interprets statistical data to have at least basic concepts of statistics and to know at least the most common statistical errors and misconceptions.
I have nothing to do with the NSI, nor do I claim that their index is a perfect reflection of reality. However, I believe that it is much better than what you claim and that most of your arguments are absolutely baseless. You are attacking a so-called straw man and you should correct yourself.
4) "I highly doubt that anyone would claim that it refers to the future or to the exact current moment. But still, information about the past is necessary and valuable to us in principle, precisely so that we have a better chance of predicting the future." I do not claim that the index has other claims. I note that it reflects the past (that is, it is not very useful to us today). As it became clear, the index shows INACCURATE information about the past (like any average when it is used in social science). In addition, I am interested to see how exactly you use it to predict the future - in my opinion, it is impossible, and even if it were to be done, it would be extremely inaccurate.
5) "Regarding changes in the quality of products (the example with the phone), the NSI knows about it and is working on the issue "Treating changes in quality is one of the areas that the NSI has been working on in recent years." I have not seen the NSI do it so far; that is, the fact remains that a more expensive machine would be more productive and would save more effort (costs), ceteris paribus. Still, a more expensive machine means "more inflation."
6) "In view of the above, the NSI data is far from being such a bad indicator of whether we can buy more or less with a unit of money. AVERAGE. Applying it to an individual household would be a fundamental mistake and the purpose of the index is not that at all, but to provide information to economists like you about general trends." In view of the above, the NSI data is still an inadequate measure of consumer prices and averaging is detrimental to economic information.
Because of all the averaging that is done for the final index and by categories, it is inapplicable for adequate macro-analysis. Moreover, it does not give any idea at all what caused or reduced prices – whether it was better technology that made goods more competitive and cheaper, government restrictions (for example, import taxes or export subsidies), printing money, etc. The index does not give us any particular information about supply and demand TODAY (at best, it provides distorted statistical information for the past month). That is, it does not show trends. Even less often does it reflect differences in prices by region, store, etc. (the same waffle probably costs differently in the center of Sofia, in the Rhodope Mountains and at the seaside during the season – what adequacy are we talking about then?! Could this waffle contribute to “inflation” if its price at the seaside is taken into account?!).
I'm not attacking a "straw man" - I'm criticizing an extremely inefficient statistical way of representing a reality that is too complex to be represented by an average.
Да видим:
1) "Your entire argument from here on out rests on a complete misunderstanding of what statistics are. I am convinced that no self-respecting statistician would tell you that you can take statistical data and apply it to any household that is included in the statistics. Such an operation has nothing to do with statistics and can only be the product of a person who has no concept of this science."
I have not written anywhere what a statistician would tell me. But if the data cannot be applied to individual economic agents, then what is it for? I argue that these data are not good at the macro level, and I will get to that. If I see the data on "inflation" for the month and it is, for example, 0.4%, what does that mean to me? Absolutely nothing, because it refers to some arbitrary set of some arbitrary people consuming some arbitrary things. If we are dealing with hypothetical people somewhere and their hypothetical consumption, in no case can we get a real idea of what is happening in the economy.
2) "Разбира се, средните стойности винаги крият различия в отделните им компоненти. Точно затова индексът не се представя като едно число, а е разбит на база на важни, фундаментални разлики в продуктите, така че да може да се повдигне булото на усредняването до степен, в която има смисъл от гледна точка на индекса."
Изобщо не се обхваща повече от половината страна и промоциите на магазините. В "кошницата" виждаме "Хляб и зърнени храни", но никакви разлики между производителите и дистрибуцията - в моята част на България може изобщо да няма този хляб, който се отчита, и обратното. Да, статистиците са го раздробили в различни раздели, групи и т.н., но те също страдат от проблемите на осредняването. Тоест, от потребителска гледна точка, ако искам да разбера какво се случва, ще отида до магазина, а няма да гледам индекса.
3) "Индексът е претеглен, т.е. СЕ измерват потребените обеми на различните продукти и индексът се изчислява според тях." Всъщност това може да е единствената критика към статията. Но тя не променя другите грешки в методологията и не прави индекса по-точен. Само показва, че ако, да кажем, НСИ е отчело повече потребление на Хляб и зърнени храни повишаването или намаляването на цената им ще има относително по-голям дял в крайна оценка и нищо повече. Това не променя неточността на измерителя и на методиката.
#1. Yes, and better for you. But I'm telling you, you can't attribute average statistics to individual entities that are part of the sample. Logically, mathematically, it's correct. Any statements like "what does this mean for the individual household" or "what does this mean for the price of a loaf of bread" show this fundamental misunderstanding. The last sentence also applies to #2.
#3. Now this is ridiculous. In the article you claim that the index did not take into account the consumption of products and could include products without consumption, etc. I tell you that this is not so. You tell me - but this does not increase the quality of the index. ???
#4. I assume you don't doubt the causal relationships? Of course, no one is talking about absolutely predicting the future, that's beyond our capabilities, but if you deny the possibility of prediction, you deny the possibility of a person acting rationally. Mises would argue about such statements 🙂 And whether the index is inaccurate will depend on whether you defend yourself on the other points. The fact that you call it "inaccurate" does not make it so.
#5 Just because you haven't seen it doesn't mean it's not true. People have written what they're doing about it, if you haven't asked them for the details and you're writing an article in which you claim this with conviction, I hope you can argue with more than "I haven't seen it."
#6 I don't see an argument, only adjectives.
In the following words, you continue to create a straw man, i.e., to give the index functions that its creators hardly attributed to it.
In the last paragraph - again adjectives, without argument. If reality is so complicated, let's give up and sit and meditate all day until we die :-))) The index presents only a very narrow and precisely defined aspect of reality. "Furthermore, it does not give any idea at all what caused or reduced prices" - another scarecrow, the index has no claim to provide such information...
I am not a statistician or an economist, but I believe that I have the ability to analyze, assess and reach logical conclusions. And from Mr. Vassilev's article I come to one conclusion that is automatically imposed - the information that the NSI provides has no real relevance to life and, although mathematically accurate, has no practical value, which leads me to think that it can only be used tendentiously, because it allows it to be presented in a certain light and as support for other statements. Suffice it to mention that the term "inflation" is not at all in its place, as it is given a convenient meaning. What else can we think about the information presented to us on BNT?! I am grateful that there are knowledgeable and perceptive people, like Mr. Vassilev, who also have the desire to share their knowledge. As for "Geo", your arguments against the article are irrelevant - that is, you are looking for and touching on aspects that have nothing to do with the context, but your comments make it even clearer that the NSI simply serves someone's interests, with the statistics it provides remaining without practical value, even for economics - that is, bare statistics that do not even provide a basis for correct economic conclusions.