Sunday 24th December, 2006

 

 

Light shed on inflation terms

 
 
 
 
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My mother likes to talk about the days when a week’s wages was just six pennies, and how people would go to the shop to make “goods” for the week, and get everything for the table, including clothes.

Last week, we promised to explain some more on inflation. It is about how much we pay for a basket of selected goods now, when compared to how much we would have paid for that same basket of goods in an earlier time period. But we do not go far back.

All about prices

Inflation is about prices. It is an economic indicator of the state of affairs in a country with respect to the ability of ordinary people to feed themselves, as well as provide ordinary items for the household.

Over an extended time period a “base” is developed for the basket of goods. Economists scan the environment to determine which items should be in the basket that serves as the base for establishing how prices have changed.

Because consumer tastes change and innovative products come into ordinary use, for example the computer, cellphone or the DVD player, prudent economists from time to time, establish what goods are in the basket.

What can happen in the basket is that certain items that come to the market as high-priced items such as computers and DVD players, become cheaper over the years—a price reduction. Hence some items in the basket are now priced lower and some items have continued to show rapidly rising prices.

Headline and core inflation

This then brings us to the concepts of headline inflation and core inflation. Simply put: core inflation takes the average of all the goods in the basket. The new term: headline inflation emerges when certain items in the basket are showing a price behaviour that is outside of the ordinary curve or trend.

The market has been doing just that. The increase in food prices are shooting up into the sky, way above the price increases for other items in the basket. Therefore, the price of food is in a way leading the basket, and so the term headline.

The Central Bank monitors these prices and develops tables and charts that trace how the retail prices go up and down. This is an indicator used to develop the Retail Price Index. The Consumer Price Index is similar, reflecting the consumption patterns in the country.

Financial planners know, on the basis of experience with their clients, that in a majority of households a large percentage of the income earned is spent on food. So if food prices are running away ahead of the other increases, it hurts the household more than anything else.

Consumers will forego spending money on new appliances, and family trips to Mayaro and Tobago. Instead they will focus on the necessary items such as food. They have no choice really. Households may have to squeeze money out from other places sometimes to avoid hunger.

Certainly it means cutting down on certain items in many households, across the country. It means that savings are now being diverted for immediate use. And there is a danger in that!

The most obvious is that long-term savings will dwindle if wages and salaries do not also increase with the headline inflation statistics.

But for now, I wish you a cheque wrapped up in ribbons and bows, this Christmas, to put into your corporate pension plans so you can pay for food and clothes in old age. Because, come January 1, certain avenues that allow tax savings on contributions reach a dead end.

Continued next week

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