Wednesday, April 17, 2013

Still resilient: people vs. prices

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As Iranians came back from a long new year holidays they face more volatility in their economy than they expected. Two digits inflation rate has been part of Iran’s economic reality for the past decades, however recently Statistical Center of Iran (SCI) announced that inflation has reached new heights in the last month of last Iranian year (March 2013).

According to the SCI latest report released on April 1st 2013 Consumer Price Index (CPI) has reached 601.4 using 2002-2003 as a base year. This signals an increase of 40.6 percent compared to the same month in the previous year when CPI was 427.6.  Compared with the prior month the CPI has increased by only 3 percent rising from 583.7 to 601.4. The lion share of increase in CPI belongs to increase in the price index for food products; 85.1% of the change is due to the increase in the prices of these items. Overall CPI increased by 31.5% during last Iranian calendar year (March 2012-March 2013), however this ignores the point to point increase of 40.6% and downplays the drastic increase in the price levels.

Citing these differences some argue that the data does not reflect the true inflation rate in Iran. However that argument is valid about many countries. For example Canadian government adjusts CPI estimations from time to time to keep the official value within the targeted area of 3%. Recently USA government has decided to use a different approach to using CPI in estimating the adjustments in the social security payments. The important point about CPI is not how much it is but how one can interpret its changes.

Interpreting variations of CPI many economists will remind you that an increase in CPI reflects a potential decline of shopping power for the average typical household. After all CPI is estimated using an average typical household’s consumption basket. This basket includes the average amounts of items consumed by average families. This is the practical approach to estimating CPI, however by using a fixed weight for different items and using a limited number of items CPI does not necessarily reflect all the changes. Thus it is not a good way to measure what people are actually buying at the store. It does not take into account the simple fact that shoppers might alter the amount of their purchases when the prices are rising. A household’s budget dictates the total cost it can spend, not the amount of items. When prices change a household cope by changing the amount of items they purchase. Here one must look at the numbers more closely.

Inflation: increasing at an increasing rate

The price index to for overall category of food, drink and tobacco products reached 895.6 in the last month with the price index for food items reaching 937. This is an overall increase of 57.4% compared to the same month last year, when one estimates point to point inflation in food products. In other words average typical Iranian family had to spend 57.4% more on average on food items in this Nowruz compared to the previous one. It is only logical to think that many Iranian households had to make adjustments in their consumption baskets by choosing to buy less from some products, food items in this case. Since the total consumption is not known for different items it is difficult to identify where average Iranian households had to compromise. The true welfare effects of this increase in inflation are unknown.

Traditionally SCI and Central Bank of Iran (CBI) report the average change in price indexes and not the point to point changes, which is usually higher than 12 month average.  One also needs to take into account that Iranians experience the sharpest increase in inflation during the Iranian New Year shopping season. Reporting a 12 month average would reduce the seasonality affect. However the fact remains that the inflation has increased across all the months for the last Iranian year. It is noticeable that it increased at an increasing rate during fall of 2012 and winter of 2013.  Some might argue that this pattern is not alarming and it follows the traditional business cycle in Iranian economy. However reviewing SCI report one notices that 12 month average increases in inflation for March 2012 through March 2013 are uniformly higher than the same averages for the period of March 2011 through March 2012.

Facing these changes the question remains that how an average Iranian household will react to increasing prices. One interesting observation is the number of domestic travelers during the Iranian New Year holidays. According to one estimate the number of domestic travelers passed 61 million. That is a significant number in a country of 77 million. Again this aggregate number hides the substitution effects, which might exist. It is true that some Iranians might have chosen domestic travels because traveling abroad has become too expensive following last year devaluation of Rial, Iranian domestic currency. However looking at the number of travelers one can conclude that the average Iranian family can still afford traveling and a three weeks holiday, a not insignificant fact to remember.

Reading SCI report on price indexes one has no doubt that the prices have been rising at a faster pace than before in Iran. Many observers will follow the inflation in Iran closely in coming months. However when placed in the overall context of the economy and when other economic factors are taken into account one has to admit the average typical Iranian household has remained resilient in the face of economic volatility.

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