Looking for a better consumer price index
Financial Express, June 20, 2006
Many media reports claim that consumers perceive inflation in excess
of the reported 4.7 per cent. This questions the integrity of
government statistics. In a remarkable recent episode, trade unions
have objected to the ILO that workers mistrust the revised CPI for
Industrial Workers (base year = 2001). Steps much be urgently taken to
create a trasnparent weekly CPI that is released with a lag of no
worse than a fortnight.
Currently, for watching inflation in India we have the choice of using
the CPI or the WPI. The pros and cons of the two are as follows.
Frequency: The WPI is released weekly, while the CPI is monthly.
Delays: As an example, as of today (17 June), the most recent
available WPI pertains to June 3, 2006 but the most recent available
CPI pertains to April 2006.
Choice of commodities and weights: The WPI reflects neither producer
prices nor consumer prices. It suffers from questionable choice of
commodities and weights. Adequate care has not been taken in
accurately defining the grade and physical specifications of
commodities. The CPI has a fundamentally superior methodological
foundation, for a household survey is utilised to find out the
consumption of a "typical" household, and this drives the choice of
commodities and weights.
Transparency: Data about the series going into the WPI is released
into the public domain. The CPI is much more non-transparent. When the
government releases a GDP number, households do not feel they have an
independent view about GDP. But when it comes to inflation, everyone
who shops has a view about the "true" inflation. The non-transparency
of CPI has encouraged mistrust of the CPI and conspiracy theories
about manipulation of data by the government.
So while the CPI fundamentally makes more sense than the WPI, the
usefulness of the CPI has been radically undermined owing to low
frequency, high delays and non-transparency. As a consequence, the
"headline inflation number", which is widely followed in the press,
has become the WPI.
A major achievement of macro policy in India in the last decade has
been a decline of inflation to sub-5% levels. A healthy feature of
Indian politics is that there is an uproar when inflation goes up;
this acts as a check against a government that might seek to impose an
inflation tax upon bondholders. However, inflation in India remains at
very high rates by world standards, where well run central banks
target inflation rates like 2 to 2.5%. India's finishing stretch, in
going from inflation of roughly 4% to roughly 2-2.5%, strongly
requires better measurement of inflation, for we would now be dealing
with small and subtle changes in inflation.
A committee headed by Planning Commission member Abhijit Sen has been
given the task of constructing a Producer Price Index (PPI) for
India. However, it is equally important to transform the CPI. The CPI
needs to shift to a weekly frequency, with a lag of no greater than
one fortnight. It needs a top quality methodological foundation in
terms of a household survey which is no more than 3 years old, where
the full survey database is released into the public domain, so that
there are no accusations about fudging weights or
commodities. Finally, every piece of price information that goes into
the CPI needs to be released into the public domain. This needs to be
done for historical data also, so as to enable innovative applications
of this information, and improve the trustworthiness of the CPI.
Once inflation measurement is improved, two major developments can
take place.
The first is the issuance of inflation indexed bonds. Perhaps a
quarter of the bond issuance of the GOI needs to be shifted to
inflation indexed bonds. The reason for this is two-fold. First,
households who seek to plan for old age without uncertainty about
inflation should be able to do so. Second, the secondary market
trading of inflation-indexed bonds reveals the market's perception
about expected inflation, a key ingredient that goes into monetary
policy formulation.
The second major development would be a much more modern monetary
policy that explicitly links up developments on inflation to the
short-term interest rate setting of the central banks. At present, it
is impossible for RBI to be particularly scientific about monetary
policy, for the foundation of that (inflation) is not properly
measured.
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