After the release of a news event, report or proceeding, it is commonplace as a democratic society to listen to the views of well-meaning Nigerians. In as much as there is room to air out their opinions, my countrymen express their views so expressly that it may lead to emotional outbursts atimes. While they do excellently well in certain fields like entertainment, sports, crime and politics, they are unable to provide adequate feedback when it comes to basic economic matters like inflation due to incomplete or incorrect knowledge. The trap in understanding economic concepts is that they may sound so simple but could have completely different interpretation in economic parlance.
Nigeria has experienced a consistent drop in inflation figures since January 2017, what exactly does this mean? Many Nigerians express deep distrust for such news and even go ahead to politicise the whole issue. How do you say inflation is dropping when things are getting so expensive as the day goes by? They will even go on to tell you about times when a 35cl bottle of Coca-Cola was sold for as low as N20 and Agege bread for as low as N30. Well, I make bold to break down this monster called inflation to the reading public and amend this ailing relationship between the statisticians and the streets.
Inflation can be defined as the increase in the general price level of goods and services in an economy. Don’t rejoice yet, it’s more than what you see, lets explain two confusing terms; Increase and General Price Level. Have you ever heard of general price level at the supermarket? So just hold on and read.
General Price level
To begin with, note the definition says inflation measures general price level and not individual prices alone. This means that if the price of a commodity like Coca Cola rises, inflation rate may or may not rise (in fact it could fall). This is because there are many other commodities in the beverage space and in other sectors that can be unaffected by the factors that led to the price increase in Coca Cola. In other words, an increase in the price of Coca Cola may not be caused by a macroeconomic factor – an event that affects prices, cycles, output, trade or employment in an economy. So you need to ask yourself; Is the price of Cocacola affected by something that affects all other products – automobiles, textiles etc. If the answer is probably exchange rate cost, you are sure this will affect all other commodities and could affect the general price level significantly.
If we want to measure inflation, we do not consider the price of Coca Cola, Bubble Gum, Cars or Fuel in isolation. We look at one price that houses all other prices, that’s what we call the Consumer Price Index (CPI). How then do we measure general price level since there are so many goods in the economy? This responsibility is given to the National Bureau of Statistics. What they do is that they hire agents to go to markets and gather data on the actual prices of all goods and services sold nationwide. This is done on a monthly basis. The Statisticians (NBS) then collates the prices and assigns weights to each class of good or service according to their scale of importance.
The CPI is actually a combination of several prices of several baskets of goods and services, that have their relative weights based on order of importance in the economy. The CPI has 12 baskets with Food & Non-Alcoholic Beverage (51.8%) having the largest weight while Housing Water, Electricity. Gas and Other Fuel (16.7%) takes second place and Clothing & Footwear (7.7%) accounting for the third largest component of the general price level. others include Furnishings & Household Equipment Maintenance (5%), Education (3.9%), Health (3.0%), Miscellaneous Goods & Services (1.7%), Restaurant & Hotels (1.2%), Alcoholic Beverage, Tobacco & Kola (1.1%), Recreation & Culture (0.7%) and Communication (0.7%).
Food Comes First!
As we know that food is the most important need of man and comes in various classes, colours, forms and style, it is that commodity basket that is deemed absolutely necessary for survival. However, due to its premium position in the consumer goods space and high contribution to price increments alongside energy needs, an inflation rate reading is given to acknowledge food inflation. This isolated view is necessary so as to capture the rate of change in other prices as well as remove the seasonality factor that characterizes agricultural products such as gestation periods (periods between planting and harvest for plants and between copulation and delivery for livestock).
Food could bully the inflation figure so much especially when there are threats to agricultural production such as famine, natural disasters or unchecked violence as the herdsmen crisis in the North. We see that food inflation heightened during the second half of 2017 reaching as high as 20% due to the farmers/herdsmen scare. However, food inflation has been declining of recent. Food inflation in July 2018 dropped to 12.85% from 12.98% in June 2018 signalling lesser pressure on food price (lesser pressure not lesser prices). Food inflation figures for this month (August 2018) may slightly rise due to the festivities of our Muslim brothers.
Energy; Mr. Indispensable
Speaking of energy needs, you will agree with me that virtually all sectors of the economy require power for successful operation. The fact that an oligopoly (few suppliers) are in charge of power and energy in the country that is vital in every industry shows how fast this component can aggravate the general price level. From the analysis above, you will discover that energy needs alone have a weighting of 16.7%. This alone shows that an increase in fuel prices or electricity tariffs could affect inflation greater than the giant-food item space due to the bargaining power of the suppliers and the indispensability of the product if there are no agricultural shocks (like famine).
Recall that Nigeria was thrown into tantrums when Jonathan announced the removal of fuel subsidy on New Year’s Day in 2012. This removal of subsidy on petrol led to an increase in the price of fuel to be paid by end users from N 65 to N141. What you may call a meagre N76 increase had pronounced effects on inflation why? Virtually, all sectors of the economy uses fuel to supply electricity for themselves. This led to increase in cost of transportation as conductors increase their fares, this fed quickly into the prices of food as traders increase prices to cover costs and the price spiral goes on and on to affect businesses, corporates etc. After this period, you couldn’t even afford sachet water with N5. The price of sachet water rose by 100% and rose for good (actually from N5 to N10; don’t be scared, that’s how we analysts compose our melodies).
A cursory look at CPI data from over 9 years (January 2009 – June 2018) showed that Nigeria experienced the fastest month-on-month increase in January 2012 (3.35 %), accounting for close to 30% increase in the price level in 2012. What this tells us is that inflation is most likely going to be affected by energy needs than any other factor at any given circumstance.
Headline and Core
This disruptive nature of food and energy calls for another measure of inflation to see how fast or slow prices are moving in other sectors. Abi no be so? Hence, we have the Core Index. this is an index that measures the rate of increase in the prices of all items except food items and energy needs– Core inflation. So, Core inflation measures the rise in the general price level of non-farm and non-energy items too. It comprises the other 10 components of the CPI to see how prices rise in other sectors of the economy other than the loud top two.
Meanwhile, the proxy for measuring the price change in all sectors is called the Headline Inflation. Yeah, just like the headline news that covers all stories for the newshour, the Headline Inflation shows the movement in prices of all sectors in an economy.
So now, we can easily identify the Consumer Price Index, the components of the CPI and how they affect inflation as well as the types of Inflation – Headline Inflation and Core Inflation. We’re about to slide into the part that gets confusing. We have said Inflation occurs when the general price level rises – How then do we know when inflation rises? Does a drop in inflation rate mean prices are falling? What does rising or falling inflation rate mean?
Reconciling Increase and General Prices (CPI)
Simply put, Inflation happens when the general price level rises. This means as long as the CPI is rising, there is always inflation. If the CPI falls, there is deflation.
Is falling price levels the same thing as falling inflation?
The answer is NO. Inflation rises when the CPI rises faster and inflation falls when the CPI rises at a slower rate. In other words, the speed at which the price levels rise determines whether the inflation rate rises or falls. This means a falling inflation rate doesn’t mean prices are not rising, it just means prices are rising at a slower rate. In the same vein a rising inflation rate doesn’t just mean prices are rising but it means prices are rising at a faster pace. In both cases, prices are rising but the speed of increase compared with the speed at which the previous price rose determines whether inflation goes up or down.
Rising CPI and Falling Inflation
If the CPI rises faster in the current period than in the previous period (often referred to as base period), inflation rises. The periods can be monthly or yearly. The reported figures are usually yearly in order to compare similar seasonal periods. Inflation rate currently stands at 11.14% comparing the CPI between July 2017 and July 2018. On a monthly basis inflation rate stands at 0.83% (May 2018 and June 2018). Like I said earlier, we refer to the yearly change whenever you hear inflation rates, so inflation rate is currently 11.14%, this means that the general price level rose by 11.4% between July 2017 and July 2018.
Data also shows us that although the general price level rose, inflation rate fell from June 2018 (compared to June 2017 at 11.23%) to July 2018 (compared to July 2017 at 11.14%). This simply means that prices rose slower in July 2018 than in June 2018. This is probably due to an ease in pressure on prices like exchange rate stability. In July 2017, the exchange rate situation was not as stable as it is now. This made prices rise at a steadier rate in July 2018. So it is established that prices can still rise when inflation falls because they are rising at a slower rate.
A quick flash to the subsidy example showed us that when fuel prices increased, there was a speedy response in the prices of goods and services. In fact some prices were increased so high that a strike action had to be taken by the labour union to rescind the decision or lower the price by subsidy rearrangements. This is because wages that are used to purchases goods don’t rise as fast as prices do. The problem we had is that if at all subsidy should be removed, it should have been done gradually. This will allow prices to rise steadily keeping inflation rate low. The speed at which the decision affected prices was high, that’s why inflation rose. We know price increases are good for the economy, but it should rise at a slow rate and shouldn’t rise too fast. Imagine a loaf of bread worth a thousand naira overnight. Steady increase in prices is desirable because it helps consumers plan their expenditures and adjust adequately. Unexpected price increments erodes the purchasing power of fixed income earners as it requires more money to buy the same basket of goods.
We have hereby established that Inflation rises when prices rises faster than usual and we have highlighted some things that can lead to an unprecedented rise in inflation rate such as exchange rate instability, subsidy removals, increase in electricity tariffs, shortage of food production etcetera. Let’s see why inflation is good for the economy.
Inflation is good, Why?
Inflation is actually good for the economy. What? Did I just say good? Yes, it is but the worry is that it inflation should not be too high or prices shouldn’t rise too fast, because it is a measure of consumer confidence in an economy. Inflation means rising price levels. Rising price levels means rising demand, which means more goods are produced. When more goods are produced, more people need to be employed.
In other words, if the CPI rises too fast like in the case of war, goods will become so expensive within a short period of time and people may be unable to buy. That’s why one of my lecturers back in school used to say, after war, if you want to propose to a lady, buy her a bar of soap. She’s all yours. Funny right! This is because the speed at which prices rise can erode consumer welfare. You may not be able to buy the same amount of things with the same amount of money.
So, we see that inflation reduces unemployment, but inflation has to take place steadily to avoid a fall in demand (where people cannot buy because their money have lost value).
In the same vein, general price decline (or what we economists call deflation) are bad because people will buy less due to the increase in the value of their money. When less output is bought, producers don’t make their money and they will have to layoff workers. This idea is what is known as the Phillips Curve – the higher inflation, the lower unemployment and vice versa.
What if the CPI falls, this is called Deflation. This means that the general price level falls as a whole (remember this is not the same as fall in the price of Pepsi alone). A fall in the CPI can be caused by appreciation in the exchange rate. However, an appreciation in the exchange rate can also lead to a slower rise in the CPI especially in a consuming nation like Nigeria where there’s a lot of impulse buying (latest phones, shoes, movies etc.). Assuming, Nigeria government makes her business environment so conducive that investors are bringing in their dollars to establish partnerships in key sectors in Nigeria making our foreign reserves skyrocket to let say $200 trillion. This means a lot of dollar comes into the economy and more dollars will be available for exporters and forex users. This will lead to improved exchange rates (like N100 to a dollar), reduce the forex cost of importing goods and boost manufacturing sector up to the extent that so many producers will be competing for customers. This competition can ultimately reduce the prices of key items in the economy (this is far from reality, Nigeria’s consumption pattern will continuously be outrageous due to the Joneses effect – spending like rich neighbours). Deflation could actually hurt the economy because prices will crumble due to excess supply, this means there is capacity over-utilisation, machines will be shut down and workers laid off etc.
Nigeria’s Inflation Story
The good news about Nigeria that many were upset with is the fact that the NBS reported that inflation rates have fallen for 18 consecutive months. I hope we can understand what the statisticians are trying to say now. They are simply saying that between January 2017 to July 2018 (at the writing of this report- August 2018), prices have been rising at a slower rate. That’s all, they never said prices are falling. All they want us to know is there are some factors that may have been responsible for this free fall in speed of price increases.
First of all, we saw prices rose faster within 2016, Imagine Inflation left the target band (between 6-9%) of the CBN and hell was let loose at the rate of price increases just within one year, what really happened? We see that Nigeria’s mainstay – oil, which produces over 90% of foreign exchange earnings was severely under threat due to the falling crude prices in the international market and domestic pipeline mishaps perpetrated by Niger Delta militants. This affected oil output, which in turn affected our store of foreign currency (foreign reserves) so much that it depleted to miserably low levels. This led to the floating of the Naira in June 2016. What that means is that the demand for dollars (by importers for instance) and supply of dollars (by oil revenues or foreign investment) had to determine how much naira to be exchanged for dollars without CBN intervention (for a while). Guess what happens when the demand for public transport is close to 50 people at the bus stop and you have an 18-seater bus coming, the fare will rise very fast, wouldn’t it? This is what happened as people had to pay more naira to get a dollar. The CBN had to put so much policies in places including rationing dollars to be kept in houses as well as ensuring all transactions within the country are denominated in naira. All these were put in place to stem the stiff-neckedness of long-throat gain hunters, who want to sell their dollars for increasingly high amounts. This had an alarming impact on prices across the economy due to the necessities of life that are highly dependent on dollar availability. It must have really been a tough year for the monetary authorities I must confess. This culminated in a technical recession in the second quarter of 2016. Recession simply refers to a period of negative growth in the GDP after two consecutive declines in the output growth rate. It is characterised by high inflation, unemployment and weakened aggregate demand.
Luckily for us, the aggrieved militants decided to retreat and that marked the beginning of recovery in oil production. In fact by the second quarter of 2017, we were out of recession due to the opposite of the causal factors in the first place – ceasefire by militants and Deal of Cooperation. The Deal of Cooperation was an agreement by OPEC countries to reduce supply so as to buoy prices that had fallen to as low as $30 per barrel. As from January 2017, inflation started to drop meaning prices rose at a slower rate and another breakthrough in the exchange rate occurred in April 2017 to further concretise slower price increases. This was the introduction of a market-based exchange rate platform known as the Investors/Exporters Window where demand and supply determines the exchange rate. This has led to a rapid accretion to our foreign reserves boosting our ability to meet forex demands. Exchange rate appreciated from as low as 400 to settle somewhere around 360 naira to a dollar before improving to the current level. Like I told you earlier, exchange rate appreciation feeds positively on the inflation rate.
As things stand currently in the Nigerian economy, inflation rate forecasts by analysts see a continual fall in the inflation rate (we call this disinflation in economics) towards single digit level. The only deterrents to such outlook is pre-election spending, likely impact of herdsmen clashes when gestation period is over, likely increase in electricity tariffs to reflect the market situation. Do you see now why inflation could likely fall for the rest of the year? As long as there are no macroeconomic shocks or policy triggers, we should achieve single digit rates before the end of the year.
I hope you’ve learnt a lot. Here is a quick recap; We have said The CPI measures all goods in the Nigerian economy assigning weights based on order of usage and importance. When CPI rises, there is inflation; when CPI falls, that’s deflation. Inflation simply measures the speed at which prices measured by the CPI rise in an economy. We said inflation is good for the economy because it spurs employment but should be kept at sustainable levels so as not to erode consumer’s welfare as rapid price increases do not come with rise in wages in the real world. Inflation rate is computed by the National Bureau of Statistics (in Nigeria) through monthly market surveys. The official headline inflation figure reported compares price increments between similar period in a year. We also saw that inflation rises when CPI rises at a faster rate and inflation declines (or disinflation occurs) when CPI rises at a slower rate. This means that prices could still be rising when inflation is falling. Finally, we considered the Nigerian situation; why prices rose faster prior to January 2017, why prices have been rising at a slower pace since recovery from recession and why they may likely maintain a further drag in coming months.
Do well to familiarise yourselves with all key items. Next time you get interviewed on inflation, give it to them like an economic literate. It’s very simple to understand.
Happy Macroeconomic Literacy