Predatory third world governments have standard responses to money printing, which causes inflation and balance of payments crises; starting with exchange controls, import controls, and - you guessed it - manipulating the inflation index to understate inflation.
Typically what money printing governments do is to take out or reduce the weight of items that are moving up the fastest.
The main reason they do this of course is to avoid political embarrassment. As fuss-budget has pointed out in previous Thrift Columns, inflation is the final scorecard of macro-economic management, or in the case of third world countries like Sri Lanka, the lack of it.
The other reason is to defraud workers. In The Thrift Column - Monetary Plunder we showed how Sri Lanka's government and big business plunder the poor, the assetless and working classes through the hidden tax of money printing, negative real rates and budget deficits.
But the indexing of wages and other benefits to a Consumer Price Index (CPI) prevents a government from profiting through inflation. So you change the index.
Sri Lanka has produced several CPI indexes earlier. But they were not recognized as 'official' because the trade unions had refused to accept them, guessing rightly that the government was trying to short change them.
When Sri Lanka's politicians - and officials as well as mis-guided economists who parrot the propaganda - say the Colombo Consumer Price Index (CCPI) is wrong, its base is too old, it has too much food in it, it is not representative (bottom 20 percent of Colombo's workers), etc, etc what they are really saying is that it is too high for their political comfort.
Once upon a time inflation was not defined as 'a rise in general price levels' but as an increase in the quantity of money. The Bullion Report of 1810 commissioned by Britain's parliament to report on a fall of the Pound hit the nail on the head two centuries ago when it said, 'Inflation is an increase in the money supply'.
You can still see this in old dictionaries, though you may not see them in post-Keynesian economic texts.
Politicians love the idea of central banks and money printing because it gives them power to spend, and politics rather than economics is perhaps more responsible for the change in the definition.
Now the inflation definition has no cause, as if the 'general price level' just goes up for the heck of it.
This is also why the concept of cost-push inflation has captured the imagination of politicians and also central bankers who want to hide their inability to maintain price stability.
If there is so much cost-push inflation how come developed countries keep inflation at 2 or 3 percent? How did Maldives keep it at 3.7 percent with GDP growth of 18.2 percent last year? How does Singapore keep it at 1.2 percent?
In fact, productivity is growing so fast that the tendency for most modern economies is to deflate. For example fish prices fall in the Maldives despite rising fuel costs.
What a 2.0 percent 'inflation target' does is to allow governments to print just a bit of extra money and supplement their tax incomes, without hurting the poor too much.
That is why the Fed tightens monetary policy when oil prices rise. Our central bankers will say how can you fight cost-push inflation with monetary tightening?
In reality what happens is that the US government goes without some of the productivity gains or deflation it would have skimmed off through money printing to compensate for the rise in oil prices.
Even Sri Lanka imports all the global technological developments that go towards productivity growth; computers, cell-phones, new production methods and what-not.
Not only that, as a trading nation we import the productivity gains of other economies when we import goods.
That is partly why inflation plummeted in 2002-2003 when money printing stopped, despite items like petroleum going up every month.
The official argument that the CCPI is not representative and should be scrapped as a wage index tool because it represents only the bottom 20 percent of Colombo's workers is clearly nonsense, as well as being a typical argument that we can expect from a predatory third-world pseudo-pro-poor government, or even a less predatory one in a developed country.
This is exactly what a cost of living allowance should give. The poorest of the poor segments of workers, most of whose salary goes to food, should get enough of a cost of living allowance adjustment to eat.
What does the government, the high powered economic council and the economic pundits who trash the CCPI expect the bottom 20 percent of manual workers to do? Starve?
For example the United States uses a CPI calculated by the Bureau of Labour Statistics (BLS) called the CPI-W meaning workers inflation (bottom 32 percent of the population), to index wages.
In fact Sri Lanka's CCPI was adjusted, which the pundits have conveniently forgotten.
Then the Sri Lanka Consumer Price Index covers the bottom 80 percent of the population. It has a 1996-1997 base, but that also largely shows the same trend as the CCPI.
However SLCPI sometimes move faster than the other in a 12-month period.
But if you take a longer period both indexes show the same inflation despite their weights being different.
For example in the 12-months to January 2002 the CCPI grew 8.8 percent and the SLCPI grew 13.6 percent.
But 25-months later in February 2003 the CCPI had grown by 22.3 percent and the SLCPI by 21.7 percent, a difference of just over one half of a percentage point.
Or take the 4-year period from January 2001 to January 2005, the CCPI grew by 42.5 percent, and the also SLCPI by 42.4 percent.
Both indices if fact showed exactly the same inflation over a 4-year period. Why?
That is because the index showed how much the value of the rupee has fallen compared to the goods and services available in the economy.
Any basket broad enough is likely to show the same inflation.
This shows that the arguments against CCPI are baseless and are simply politically motivated.
In fact a cursory glance at the graph 'Fairest Index' will show you that the CCPI which is Colombo-based follows monetary conditions or printed money much more quickly and closely than the country-wide SLCPI.
Of course, you can 'doctor' the basket to show lower inflation. If you put a lot of imports in a basket it may grow slowly because it will reflect productivity gains in foreign countries.
This type of manipulation is found not only in third world basket case countries but also the United States, the home of the Federal Reserve and low inflation. But more on that later.
Are food prices more volatile? Surely so. Vegetables and fish are more volatile because they are domestically produced and cannot be readily imported. So they respond first to money printing. Products that are imported will be affected later when the currency depreciates.
(If the statistics department wants to take a page out of the United States book they can use a lot of food prepared outside-the-home in the index because commercial food prices do not change immediately unlike at-home-produced food.)
An index that has a higher proportion of food will certainly grow faster. Rents, house prices will adjust much later. When an asset bubble pushes house prices up, rents will go up maybe one year or two years down the line.
Then of course exchange rates will depreciate almost immediately if you print a lot of money (balance of payments crisis) but any unadjusted inflation differential (like now a 13.7 percent overvaluation of the real effective exchange rate) takes longer to correct.
Such technical overvaluations may correct only several years after a money printing binge when exporters and domestic producers have been given a good thumping and the trade deficit widens.
So naturally when economists say there is a 24-month relationship between M2b and the price index they are correct. Some things take time to adjust. But make no mistake, if you print a lot of money prices go up immediately, like in two to six weeks.
We showed in The Thrift Column – Rupee Slide how the relationship between M2b growth and inflation completely broke down in 2006. There isn't a direct relationship between M1 growth even.
That is because when inflation goes up very fast, and you create a balance of payments crisis, and if the central bank tries to defend the rupee, M1crash lands spectacularly, dragging M2 with it (due to foreign reserve loss), while inflation continues to move up until the excess demand is dissipated or the rupee depreciates.
It is really funny to see high powered economists saying pompously that monetary policy will take 18 months to take effect, or 24 months to take effect, etc.
Do they really think that just because a bank note has a signature from a finance minister of a two-bit third world country, that it has acquired divine powers allowing it to behave differently from any other commodity? Come on, tell that to the birdies!
The Sri Lanka rupee is just like Sri Lanka paddy. It cannot be exported. If you over-produce, its price falls. And pretty quickly, just like paddy.
America can get away with more money printing than us because dollars can be exported, like Sri Lankan tea. There are enough people out there who are willing to use dollars backed by relatively better monetary policy, so Uncle Sam can sit there and collect seigniorage revenues quite happily.
I mean let's face it, you don't even need the US Federal Reserve to buy US government debt, central banks from China to Sri Lanka are queuing up to do it with tongues hanging out.
The ignorant so-called leftists like the JVP, the do-gooding Oxfams of this world think that the US enslaves the world through IMF and World Bank conditions and their loans.
Think again. It is the IMF and World Bank conditions that allow us to stand on our own two feet, while it is the mis-guided policies that make our economy and our currency subservient to that of the United States.
Can the poverty merchants of the so-called 'left' even understand the concept of billions upon billions dollars of seigniorage revenues that the 'hard currency' nations are skimming off the rest of the world, aided and abetted by their very own actions?
Now the good lady that runs the Census Department has reportedly denied that she is going construct an index that understates inflation. She is going to put three-wheeler prices, private tuition, and medical care into the new index and do a professional job.
What happens if that index shows an even higher inflation than the CCPI? It is to be hoped that the recent fate of her colleague in Argentina does not befall her.
Argentina is a typical badly managed Latin American country with high inflation and high concentrations of wealth. In its time it has had 700 percent inflation, debt default, BOP crises the lot.
It has tried to abolish the central bank and go back to a currency board. It has 'dollarised' the economy. But its budget deficits and populist politics keep getting in the way. Not surprisingly the state is always trying to find ways to show lower inflation.
One brainwave of the current Kirchner government was to restrict meat exports to prevent beef prices from going up and put price controls. Farmers then switched from beef to soybean production and now beef prices are even higher and there are less export earnings as well.
Kirshner can surely teach a thing or two to our Somawansas and Weerawansas and presumably our economic policy committee as well.
The government in Argentina has been complaining just like ours and any other money printing state in monetary history, that their index overstates inflation.
In February 2007 inflation in Argentina was uncomfortably high. President Kirchner's answer? Replace Graciela Bevacqua, the lady who was in charge of price indices at Indec, Argentina's national statistics office!
Fuss-budget in The Thrift Column – Last Refuge said the 'core inflation' index of the central bank was like a transparent thong bikini that did not cover the nakedness of the central bank, when in 2006, authorities claimed the 'core inflation' index was going down and did not tighten monetary policy.
It went down obviously because they took out the goods that responded most quickly to inflation, and kept the rest, like rents which takes years to adjust and the miscellaneous items of the index. (Actually miscellaneous section also mimics the overall index though the percentages are less, just do the numbers and see).
It is so sad that the central bank is trying to conduct monetary policy on what is clearly a lagging indicator. You need leading indicators not lagging ones.
In the annual report issued last month, the central bank said there was demand pressure in 2006: "This was indicated by the rising trend of core inflation, which is the part of overall inflation more sensitive to monetary expansion"
Sad. Really, really, sad. What does the central bank imagine vegetables and other foods are priced with? The currency units of la la land? And not the rupees blighted by printing? Do you really believe that?
Everybody laugh! Ha! Ha! You can excuse the Bank of England for using RPI-X because they are trying to target a 2 percent inflation rate and do not want to tighten monetary policy unnecessarily because inflation goes up by an extra tenth of one percent.
But we have inflation of 8, 10, 15 and 20 percent, for the love of little apples! Those are not targets that you have to hit with a sniper rifle with a telescopic sight.
Even 10 percent is like the side of a house even blind man should be able to hit. You should not need a core inflation index to tell you that your inflation is monetary if it is higher than one or two percent.
If we do not mess-around with domestic taxes, an open trading economy should only have the average global inflation rate - or less if there are productivity gains.
Central Bank also seems to be more confused about the use of core-inflation as a target in other countries.
"Many countries use core inflation in the conduct of monetary policy, as core inflation is an indicator that could be targeted by monetary policy with a greater effectiveness," the annual report said.
Beg pardon learned Sirs and Mesdames. Countries that have inflation targeting, (including Britain) do not really target core inflation.
In a country that has an inflation targeting regime the parliament gives a headline inflation target to the monetary authority which they have to keep - at least parliaments that have worked out the basic truths about inflation.
Say Britain gives a 2 percent target to the Bank of England. In Britain from 2003 this has been the CPI not RPI-X.
This is natural enough and is in the tradition of other countries which pioneered inflation targeting.
After all that is the inflation that the people feel, that is the inflation that elections could be won and lost, and that is the inflation that the government wants to reduce to keep wage and pension and other indexed costs down.
There is no point in targeting some theoretical core-inflation number that only the boffins in a central bank can detect through their complex algorithms.
Of course a monetary authority can use the core-inflation index to make decisions on when, and what action to take, in order target the CPI inflation, just like watching industrial growth, the external sector, labour markets and so on.
The case in the US is slightly different because there is no explicit inflation targeting framework in place. It is also true that the Fed now uses core-inflation in its reports to Congress (a core based on the Personal Consumption Expenditure Index since 2000).
But then there is a whole can of worms behind this whole index issue in the US - particularly headline inflation numbers.
The attempts by Sri Lanka's economic policy mandarins and the Department of Census and Statistics to manipulate the CCPI seem amateurish compared to what the US authorities have done to their CPI to understate inflation.
This is done to save index linked payments of the US government, such as wages, pensions, Medicare and interest costs – (not just US Treasury Inflation Protected Securities but bond buyers also demand yields based on market expectations of inflation).
One tenth of an index point represents billions upon billions of dollars in costs or savings to the US government.
So they set about manipulating the index. This goes beyond mixing a bit of commercial food prices with home produced foods.
The BLS introduced 'geometric weighting', where the weighting of the fastest rising goods and services are reduced or taken off altogether!
If beef prices are rising for example, it is taken off and substituted with a cheaper alternative (say chicken) on the principle that people will switch to a cheaper close substitute.
All well and good, but critics point out that this actually represents a lowering of living standards as a result of inflation, and violating the basic principle of constructing an index, by changing the basket.
Then there is 'hedonic regression'. That is to say that when the quality of a good increases - say a computer's clock speed goes up - its price increase is ignored because it now give us more 'pleasure'.
But critics point out that the reverse is not done, when the quality of a good decreases!
Most of this was the work of Micheal Boskin (government) and Alan Greenspan (Fed) both of whom had vested interests in showing lower inflation.
All this makes CPI a joke according to critics in the US who estimate that headline inflation is understated between 0.3 – 0.5 percent a year now compared to how it was measured two decades ago. That is why they also point out that USA is now having high growth rates, through a lower GDP deflator.
If their inflation was so right how did an asset bubble develop in the nineteen 1990's? And how come the dollar is sliding against the Euro?
Funnily enough in February 2007 US CPI was 2.4 percent while the core inflation was 2.7 percent! The core number has been higher for some months with energy prices easing.
If core-PCE inflation continues to be higher than headline inflation for a long time you can expect the Fed to focus on some other 'more convenient' inflation index.
Having said that US inflation is quite low whatever the manipulation, so people do not get hurt too much, and they do have high living standards.
But if there is some catastrophe in the future and the dollar continues to slide against the Euro (the European Central Bank influenced by the likes of anti-money printing Germans are likely not to meddle with indices as much as the US) there may be a congressional inquiry and this whole system may be overhauled in the future.
You can now clearly see that the criticism of the Sri Lankan CCPI is political because all the official accusations claim that it has an upward bias.
No government ever says that an index has a downward bias and tries to revise it upwards.That is only said by us poor non-technical chickens who go the market with our dwindling real salaries and find that we cannot feed our hungry families three months after the government prints tens of billions of rupees to finance a people-friendly budget deficit.
Brickbats to [email protected] You may also use the comments tab to post your responses.