The Problem with Comparing Inflation Numbers

In the previous couple of articles, we listed down the problems with the procedure used to collect numbers related to inflation. In this article, we will go a step further. In this article, the central point being said is that even after all the efforts are done and the numbers are collected they aren’t really useful. Let’s understand this argument in greater detail.

The first thing that we need to understand is that numbers on their own do not mean a lot. True analysis starts happening when comparisons are drawn between numbers. In the corporate world too, numbers are used to find out the best practices and then benchmarking is done to develop those best practices.

For example, if we know that India has a 6% inflation there is very little we can do with this information. On the other hand, if we know that India has a 6% inflation but US has 3% inflation, the situation changes. We should ideally now know that the US is doing something better than India and hence US policies should be studied.

However, unfortunately this cannot be done under the current system. Under the current system, making any comparisons between inflation numbers of different countries is usually impossible. Surprising, isn’t it! Yet, it is true. Let’s learn why this is the case:

Flaw #1: WPI vs. CPI comparisons

Inflation can be measured at two different price points. As a matter of fact, inflation can be measured at multiple price points. However, it is usually measured at two different price points. Inflation could be measured from the price data collected at the wholesale market level. This is called the wholesale price index or the WPI. Alternatively, it could also be calculated from the data collected at the retail market level. This is known as Consumer Price Index (CPI) or Retail Price Index (RPI).

Now, it takes no genius to guess that WPI numbers are absolutely, under no circumstances comparable to CPI numbers, isn’t it? However, still we have countries like India which calculate inflation based on the WPI number while countries like US calculate their inflation based on the RPI number. Hence, any comparison between the two numbers is null and void. The numbers are simply incomparable.

Some countries in the world follow the CPI system and others follow the WPI system. Due to lack of coherence between these systems, the results cannot be compared. Hence despite the massive amounts of time and money being spent, almost no analysis is possible.

Flaw #2: CPI vs. CPI comparisons

Now, we are clear that CPI vs WPI comparisons are not possible and vice versa. However, it is surprising to know that in most cases even CPI to CPI comparisons are not possible. This is because every CPI number is compiled based on the consumer price index defined by that particular country. Hence, country A will choose its own goods, choose the weights to be assigned to those goods and as a result create their own index. This will also be the case with country B! Notice that each index is custom made. Hence the goods chosen and the weights allocated will differ from one another. Therefore, in this case too, comparisons cannot be made. Despite all the money and effort spent, no analysis is possible regardless of whether comparisons are made against CPI or WPI numbers!

So what can inflation numbers be compared to?

So, if inflation figures cannot be compared to the inflation figures of any country, then what can they be compared to and why are they even collected. Well, inflation numbers can only be compared to inflation numbers in the past that were derived using the same index. So, unless India has made changes to its inflation index, the population can compare the number across time periods. This obviously is a severe handicap and a very limited use of inflation numbers.

When can’t inflation numbers be compared with the previous years?

In case the government decides to change the component goods or the weight assigned to those goods in an index, then there can be no comparisons made. This is one of the reasons why countries are very slow to change the components of the price index. But this really is a no-win situation.

Countries usually face the choice between:

  1. Having redundant inflation numbers based on an outdated basket of goods
  2. Updating the basket of goods but making it difficult to compare inflation numbers with the previous years.

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Managerial Economics