US$ inflation, ZW$ inflation, blended inflation and now geometric aggregation to blended inflation

ZIMSTAT has changed inflation calculation methodology, moving away from modified Laspeyres formula to the geometric mean formula, with inflation reported at 18.4% in September year-on-year up from 17.7% in August.

Year-on-year inflation was last reported at 77.2% in August using the modified Laspeyres formula. This has raised concerns and speculation among many stakeholders as to whether the national statistics agency is trying to massage the numbers to make them look better.

Rate of inflation is an important yardstick as it is used for policy formulation. Using the modified Laspeyres, Zimbabwe was in a hyperinflationary environment justifying the move by the authorities to peg lending rates above 100% as shown below.

High interest rates discouraged borrowing and also curtailed money supply growth through the bank lending channel. This managed to drive inflation downwards.

However, using the current methodology that has been adopted by ZimStat, inflation in Zimbabwe though high has never breached the 100% mark. How then do the authorities justify the setting of interest rates so high that they have disrupted banks’ performance, suppressed demand and limited the flow of capital?

If the authorities accept that the geometric methodology is the best measure of inflation in Zimbabwe, then they have to contend that they have been implementing wrong policies.

To simplify, the modified Laspeyres formula estimates the monthly price of a fixed basket of goods and services. In contrast, the geometric mean estimates the price of a varying basket of goods and services.

If all prices within the basket increase by the same amount, say 10%, then both the modified Laspeyres and the geometric mean will show the index increasing by 10%. In that case, there is no problem on the methodology used. The two formulae, however,  will give different results  if prices of items within the same basket increase by different proportions.

For example, suppose the sample market basket for bread in Bulawayo consists of two items, a loaf of Baker’s Inn Bread and a loaf of Lobel’s Bread. If the price of Baker’s Inn Bread increases from US$1 to US$1.50, while the price of Lobel’s Bread remains equal to US$1, then the price of the fixed market basket increases from US$2 to $2.50, an increase of 25%. That is the price increase that would be reported by the modified Laspeyres formula.

The geometric mean formula, however, assumes that the market basket varies in a specific manner with the change in relative price between Baker’s Inn Bread and Lobel’s Bread. In particular, the geometric mean formula assumes that the quantities of the two types of bread that are purchased adjust so that relative expenditures on the two items remain constant. In our example, the market basket shifts to include roughly 20% more of the Lobel’s Bread (now relatively less expensive) and 20% less of the Baker’s Inn Bread (now relatively more expensive). The price of the market basket increases 22.5% under the geometric mean formula.

This implies that there is an element of substitution of goods in the same basket with respect to price changes. ZimStat now acknowledges that Zimbabweans do respond to changes in relative prices by changing their consumption bundles and the conceptual cost-of-living index ought to incorporate those responses.

However, the major challenge is the data collected in constructing the Consumer Price Index (CPI) do not provide enough information about shifts in quantities and expenditures to determine whether consumer substitution behaviour at the lowest level more closely mimics the first, fixed market-basket scenario, or the second scenario in which quantities are adjusted to hold the share of expenditures on each item constant, making the process more of an academic exercise.

Indeed, Zimbabweans have been responding to price changes by either substituting the payment method, looking for cheaper alternatives or spending more in informal markets which are difficult to monitor. Under normal circumstances, the modified Laspeyres methodology, if used consistently, should not provide figures that are way off from the geometric mean methodology.

The huge disparity in the numbers when calculated using both methodologies in Zimbabwe highlights how the economy is highly informalised and the challenging task ZimStat has in coming up with reliable statistics that can be used for policy formulation.

Surprisingly, the number one user of inflation data, the Reserve Bank of Zimbabwe, has been defending ZimStat’s modified Lasperyers methodology and issued a statement published in The Herald of 23 January 2018.

This raises serious concerns among all stakeholders and economic agency regulated by RBZ. More communication and transparency therefore is needed from the sole and official statistics agent in Zimbabwe to instil confidence, otherwise stakeholders may end up relying on other sources.

About the writer: Kaduwo is a researcher and economist. Contact: [email protected] call/Whatsapp +263773376128