Don’t Play With Statistics
February 06, 2007
By Eric Chaney | London
As the French presidential election comes closer — the first round will take place on April 22 — three themes are emerging as pivotal domestic issues: income (cost of living, households’ purchasing power, wages) — by far the most popular; employment (labour contracts, 35-hours, unemployment benefit reforms); and, to many observers’ surprise, public finances (government and welfare funds deficits, gross public debt). Issues that economists would consider as crucial, such as the minimum wage, pension liabilities, healthcare spending trends or product market regulation, not even mentioning foreign policy, leave the French public indifferent, either because there is a broad consensus about them — this is the case for foreign policy, for instance — or because none of the mainstream candidates are emphasizing the need for structural changes in these areas.
Unfortunately for the quality of the electoral debate, a fair assessment of the current situation is made difficult by a pointless and potentially dangerous debate on economic statistics. Debating the quality of statistics in order to improve their reliability and accuracy is a good thing, but what I hear on airwaves and read in popular blogs is different: not only politicians but also journalists and the public at large are questioning the very validity of key statistics such as the CPI or the unemployment rate. Let me review these two items. ‘Minister, will you change this price index?’ ‘Mr. Minister, when are you going to change this price index, which nobody believes in anymore?’ was one the questions asked by a seasoned journalist from a well-established radio broadcaster I was listening to the other day, to the Minister delegate for the Budget. The Minister wisely refused to subscribe to the journalist’s judgment, but in my view, the harm was done, first because this journalist was probably right about the general public sentiment relative to price statistics and second because he thought it perfectly legitimate to ask a member of the government to interfere with the production of statistics. Let’s look at the facts. Why is inflation perception so stubbornly high? According to the nationwide CPI produced by the statistical office (INSEE), inflation averaged 1.9% from 2002 to 2006 and dropped to as low as 1.5% in December 2006. Over the same period of time — that is, since the introduction of the euro for the public — French consumers polled by INSEE in the monthly household survey believed that inflation was permanently higher than officially measured, in so far as it is possible to quantify qualitative answers. The reason for this gap, which is not peculiar to France, is that consumers, who have a long memory, have not forgotten that prices of services such as cafés and restaurants went through the roof when price tags were re-written in euros. Moreover, and contrary to their initial expectations, these prices did not settle down. Since consumers are upset by the level of many prices, they answer questions about price changes with a perception bias, which could be as high as 2 percentage points. However, nothing major has significantly changed in the CPI methodology. All this is well known and not really new, but because officials (Bank of France, ECB, Treasury) were in a state of denial at the time of the switch to the euro, the credibility of the thermometer, i.e., the CPI index, was seriously tarnished, with collateral damage extending to the public perception of the benefits (or inconveniences) of the single currency itself and to the current economic policy debate. The current political debate may spur wage demands Since the populace and popular media are convinced that inflation is much higher than officially measured, it is no wonder that wages and earnings are at the forefront of electoral speeches. To his credit, Mr. Sarkozy is focusing on the ‘purchasing power of workers’ rather than on nominal wages, so far. He argues that wage earners should be given the right to work longer hours in order to improve their living standards, which is both common sense and sound economics, in my view. However, since he hired Mr. Chirac’s former speechwriter, Mr. Guaino, who suggested to the then candidate the famous sentence ‘wages are not the enemy of jobs’, Nicolas Sarkozy’s speeches are, maybe wrongly, understood as supporting demands for higher wages. Since the UMP candidate is also fiercely criticising the ECB’s mandate to focus primarily on price stability, this interpretation is understandable. On Mrs. Segolène Royal’s side, the formula ‘purchasing power of wage-earners’ is a constant motto. Although not specific on wages — she won’t unveil her platform before February 11 — most observers read between the lines that she would be in favour of significant wage increases. For what it’s worth, the Socialist Party platform calls for a quick increase of the minimum wage to 1,500 euros (“as early as possible during the mandate”), a 20% increase from the current level. However damaging for jobs this proposition is, it might be difficult for Mrs. Royal, who is currently lagging behind Mr. Sarkozy in opinion polls, to step back on this issue. The irony here is that private households’ consumption of manufactured goods, the most discretionary part of the consumption basket, was up 4.3% in volume terms last year, a sign that in the real world, purchasing power is not a macroeconomic issue in France. An unwelcome polemic on unemployment figures According to monthly unemployment figures, the unemployment rate declined by a full percentage point during 2006, ending the year at 8.6% of the labour force (8.5% on Eurostat’s measure). Monthly figures are econometrically derived from claimant counts (administrative statistics from the unemployment agency) and revised every year on the basis of the quarterly labour force survey, which is the only ‘true’ source, in the sense that it fits exactly with the ILO definition of unemployment and is not biased by administrative regulations. Unfortunately, serious statistical issues, such as the percentage of non-respondents and sampling difficulties, arose last year, leading INSEE to postpone the benchmarking of unemployment figures until September. From what I understand, this was the right decision from a scientific standpoint. But it came at the wrong time and unions and political opponents were quick to accuse INSEE of having yielded to political pressures because, allegedly, the labour force survey was much less flattering than data econometrically derived from the claimant count. The unpalatable truth According to Matthieu Lemoine, a well regarded labour economist, the ‘true’ number is more likely to be 9.0% than 8.6% (“Chômage: que peut-on dire sans thermomètre?” Telos, February 1, 2007). Even so, two facts remain: first, the unemployment rate is declining in France as it is in most other EMU countries; second, France is now recording the highest unemployment rate of the euro area, together with Greece and Spain. This unpalatable truth, which in my view shows how urgent in-depth reforms of the French labour market are required, is often blurred by the fact that, in Germany, the official unemployment figure directly derived from the claimant count is 9.5%, much higher than the internationally comparable measure computed from the labour force survey, which stands at 7.9%. In the end, the polemic about unemployment figures gives the general public the impression that officials are hiding the truth and that reforms are unhelpful. I fear that this might make the implementation of reforms more difficult for the next cabinet. Give them formal independence If Charles de Montesquieu had had a preview of our modern economies, he would have probably added the production of national statistics to the list of activities that must be kept jealously independent from other powers and given the necessary means. The irony is that in the country of the author of ‘The Spirit of Laws’, the Statistical Institute is, although operationally independent, still a directorate of the Treasury. Given that, who could blame the public when it suspects (wrongly as I can personally testify) that statisticians may be under political influence? I believe that the next government should consider giving more administrative independence to the National Statistical Office (INSEE). The problems policy makers should tackle are not about thermometers but about the reality of the French economy.
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Brazil: As Good As Inflation Gets?
February 06, 2007
By Gray Newman | New York
After posting one of the lowest annual inflation readings in more than half a century, many Brazil watchers think the inflation picture is as good as it gets. We disagree. If anything, we suspect that in the coming months we may be required to lower our inflation forecast of 4.1% for the year, and that the market will follow. Our bullishness on Brazil’s inflation success doesn’t mean that Brazil cannot see cyclical pressures on inflation again. But the kind of upturns that wreaked havoc on Brazil for decades — and most importantly, which still appear to be responsible for some of the pricing in the yield curve — are simply unlikely to stage a return, in our view. Brazil’s traumatic inflation experiences of the past belong in the history books, not in Brazil’s yield curve. First, however, let’s review the arguments of the naysayers. Up, up and away The position of the inflation naysayers does have some merits. After all, history has not been on the side of those calling for inflation to beat the near record set this past year. With the exception of the bout of deflation in 1998 when the authorities were burning through tens of billions of dollars in reserves to try to maintain a fixed exchange rate, one has to go back to the 1940s to find a year-end inflation reading close to the 3.1% posted in 2006. We had to use Sao Paulo’s inflation measure in the 1940s, since Brazil did not even have a national inflation measure at the time. Furthermore, the 2006 inflation reading likely exaggerated the drop in inflation last year. Measures of core inflation vary, but the average of the three most commonly cited by the central bank suggests that core inflation ended last year somewhere between 3.6% and just over 4%, in contrast to the headline report of 3.1%. A bout of food deflation helped to explain most of the gap between headline and core measures of inflation. Even if inflation remains stable in 2007, the naysayers note, headline numbers are likely to trend closer to 4% than to 3.1%. With Brazil showing signs of economic activity and domestic demand gaining pace, the risk is tilted towards higher inflation, the naysayers add. While the economy has grown by less than most expected in 2006, most Brazil watchers expect to see the improvement in 2H06 gain ground in 2007. Retail sales, which grew on average by 6.1% in the 12 months through November, picked up pace in 4Q, with growth of nearly 7% in October and 9.2% in November. Finally, the naysayers point to relaxation on the fiscal front as a warning sign on the inflation front. While the growth acceleration pact announced on January 22 was vague, it offered room for extra spending of up to 0.5% of GDP; if fully executed, this could produce Brazil’s smallest primary surplus (3.75% of GDP) in the past five years. And the implications seem clear for monetary policy: the central bank has warned that fiscal stimulus might produce a level of demand growth which would limit the central bank’s ability to ease rates in every set of minutes of the Copom since March 2006. The death of inflation We’d highlight three problems with the school of thought that argues that Brazil’s inflation performance in 2006 was as good as it gets. First, we are skeptical of the argument that stronger demand is likely to produce greater inflationary pressures in 2007. As we have seen around the globe, the traditional macro relationships between output gap and inflation are much weaker today than in the past. Globalization has driven a wedge between the old links between labor costs and inflation, the output gap and inflation and that of import prices as well. As economies have opened up, the traditional relationships are simply not as strong as import competition plays a new, more powerful role in price-setting. We are not arguing that there is no relationship between stronger domestic demand and inflation, but only that the relationship is much weaker in Brazil today when total trade as a percentage of GDP is closer to 38% than in 1995, when total trade was close to 17% of GDP. Indeed, the most recent test of the link between stronger domestic demand and inflation suggested that the relationship was negative: inflation slowed in the second half of the year even as domestic demand gained ground. Second, we are just as skeptical of the claim that fiscal stimulus represents a significant threat to inflation. In 2006, Brazil’s primary surplus fell from 4.8% in the previous year to an estimated 4.3% as election spending, cash transfers via Bolsa Familiar and higher pension outlays brought on by a minimum wage hike were felt. Yet, again, the trend was towards lower inflation still. In 2007, the stimulus, if the full amount outlined under the growth acceleration pact (0.5% of GDP) is actually executed, would be roughly the same, with primary spending declining from 4.3% to 3.75%. Third, we suspect that there is room for further disinflation in the months ahead. While it is true that Brazil has rarely seen inflation below 4% and is also true that most measures of core suggested that the headline result in 2006 might have exaggerated the improvement, we suspect that the downward trend is not over. When we break inflation into tradable, non-tradable and administered components, we see that tradable inflation has been leading the disinflationary trend in recent years. In fact, in large part due to exchange rate appreciation, tradable inflation ended 2006 near 1.3%. While we don’t expect the Brazilian real to continue to gain in nominal terms, we suspect that it will remain strong and is unlikely to produce a bout of weakness that would feed through to inflation. Meanwhile, with backward-looking administered prices likely to slow further as they benefit from past exchange rate-induced disinflation, they are unlikely to produce an uptick in 2007. And with non-tradable inflation (near 4%) higher than tradable inflation, we suspect that consumers are likely to continue to switch, on the margin, from non-tradable to tradable consumption. That move, similar to a negative demand shock for non-tradables, could pressure non-tradable inflation down further. Indeed, just such a move downward in non-tradable prices is already taking place. This would suggest that part of the improved domestic demand could contribute to more demand for tradables — where import competition is greater — relative to non-tradables. On cycles and structural breaks We aren’t arguing that inflation in Brazil is immune to business cycles or stimulus from the fiscal or monetary authorities. We are simply arguing that the traditional relationships so often cited by the central bank and by most Brazil watchers appear to be weaker today. We aren’t claiming that the episode of 2006 in which domestic demand gained ground even as inflation — with or without food, core or headline — dropped is proof that an upturn in demand leads to lower inflation. But only that the relationships are likely to be much weaker. Cycles may be alive and well in Brazil, but their impact on inflation has likely declined thanks to Brazil’s greater openness to international trade, as well as to the prudence on the fiscal front and the central bank’s work at strengthening its credibility. Of course, we may be wrong and cyclical pressures may cause an inflation upturn if demand is not satisfied by domestic production or imports or if the fiscal stimulus is much larger than we are predicting. But Brazil’s yield curve — with rates still hovering above 12% a year from now — seems to be pricing in much more than a cyclical upturn. Bottom line It is perhaps too early to call for the death of inflation in Brazil. But even after stripping out the benefits from food deflation in 2006, last year’s slowing in inflation even as demand regained ground and fiscal contraction was eased should serve as a warning sign to those who expect inflation to turn up in 2007. At present, many Brazil watchers seem to be working with the assumption that the only inflation surprise in Brazil in 2007 is likely to take the form of inflation coming in higher than expectations. We would argue just the opposite. Cycles may not be over, but they are likely to prove less potent today than in the past in determining inflation. Meanwhile, one would never know this from looking at Brazil’s yield curve. While there is a legitimate debate on whether inflation ends 2007 at 3% or 3.5% or 4%, Brazil’s yield curve still appears to be reflecting the trauma of battles of the last decade. That battle appears to have been won.
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Another 25bp Cut
February 06, 2007
By Deyi Tan | Singapore
BI cuts rate by 25bp: As expected, Bank Indonesia (BI) cut the benchmark rate by 25bps to 9.25% today.
Inflation data stable but risks emerge: January inflation data released earlier this month showed a slight deceleration to 6.3% (versus +6.6% YoY in December). Core inflation, which is a more critical gauge of demand-side pressures, remained stable at 6.1% YoY (versus +6.0% YoY). However, since the last meeting, inflation risks due to the weather have continued to emerge (first, El Niño and now Jakarta floods). In the worst-case scenario, the floods in Jakarta are likely to last until mid-February, which marks the end of the peak rainy season. This impact will likely be reflected in the February inflation data.
Currency trends and short-term flows remain favourable: However, trends in the rupiah, which is the central tenet of monetary policy, remain benign. The rupiah has depreciated slightly since the last meeting but remains in a relatively tight range of 9008-9133 against the dollar. On short-term portfolio flows, foreign equity buying remains in the positive range of Rp1.2 trillion (15-day trailing sum), but has cooled down from the high seen last month. BI to stay on track with 25bp cuts: Broadly speaking, the inflation trend continues to ride on benign base effects from the fuel price hikes in 2005, though weather-induced upside risks are present. However, such risks are temporary and the central bank is unlikely to react to these supply-side factors, in our view. Real rates are now standing slightly above 3% and we believe that the central bank is getting closer to its preferred range of real rates of about 2.5-3.0%. We expect BI rates to fall to 8.75% by year-end, higher than the current market expectations of 8.3%.
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