Saturday, February 13, 2010

Deflation Nation

On Thursday the CSO released the January update of the Consumer Price Index.  The figures reveal that the annual rate of inflation -3.9%, the highest (least negative) it has been since April 2009.  However, if we look at a measure of 'core inflation' we actually see that the inflation rate is still declining.

Here core inflation is the CPI excluding mortgage interest and energy.  The prices of these goods are largely external to the Irish economy.  Here is a graph of the overall CPI and core inflation annual rates.  Click to enlarge.

While the overall rate is trending upwards, the core rate, which is driven largely by domestic prices is falling at ever faster rates.  The overall rate is rising as the ECB interest rate cuts beginning in October 2008 are now falling out of the 12-month rate.

The general reaction to the figures has been along predictable lines.  A common theme when the CPI figures are released is that it serves to highlight so-called 'government inefficiency'.  In The Irish Examiner we have:

The small business group, ISME, warned however that while some costs are coming down, the price of many state costs are rising.   Opposition politicians echoed these warnings and attacked the Government for failing to rein in state-controlled costs.

The CSO figures show that rail travel increased by 0.3% over the year while bus fares were up 4.4%. Education costs were also up 11.3% while health costs rose by almost 2% in the year.
Here is a piece on last month's CPI release that uses comments made by Patricia Callan, director of the the Small Firms Association :
Callan called on the government to start taking the issue of restoring national cost-competitiveness seriously, in particular in the sectors where it has direct control over pricing. CSO figures show that the overall increase in the CPI from 2005 to 2009 was 8.4%, yet the equivalent rises in Education costs was 24.4%, House, Water, Electricity, Other Fuels was 19.4% and Health was 17.9%. “The Government needs to take firm action to bring the costs it imposes on the economy back in line with the CPI, so that it is not having knock-on negative impacts on small businesses who are fighting for survival”, commented Callan.
She called on the Government to immediately impose a price freeze on all publicly administered services for 2010 and specifically to instruct all local authorities to decrease commercial rates by 10% in 2010. These increased on average by 2.7% in 2009, despite annual deflation of 4.5%, and have vastly exceeded the inflation rate for many years. “When public sector inefficiencies are passed onto the rest of the economy in the form of indirect tax increases and charges, competitiveness deteriorates and jobs are lost. Our inflation rate is a key component in regaining lost competitiveness.”
These theme can be found from lots of commentators.  However, it is a load of rubbish!  From the "turning the corner" paper we can see why from the following section. Click the tables to enlarge.

The CPI measures consumer prices. For most of the public services provided in health and education, a direct money price is not charged; hence these are not included in CPI calculations. For example, the Education group which makes up 2.04% of the CPI are described in Table 3.1.

The state does not set prices in the primary or secondary sectors even though it is the main provider. Other education and driving tuition are private sector activities. The CPI Education Group tells us little about public sector provision of education as, third level aside, the consumer is insulated from cost as prices do not exist.
Although slightly more involved, a similar analysis is provided for the Health sub-group in Table A.5 in the appendix. Again the conclusion is that the CPI numbers indicate little about public sector provision of health with at least 70% of the Health sub-index made up of private sector prices.

There may be inefficiencies in the public sector but any claim of such based on CPI data are wide of the mark.

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