Why the Inflation rate is always wrong

Economists receive their fair share of criticism when it comes to predicting the future – we missed the 2007/2008 financial crisis and wrongly predicted a Brexit vote would lead to a recession in Britain. 

We aren't perfect at telling the past either – even statisticians in the United States revise growth rates months after they have been released. This is not due to incompetence but mostly a lack of data and certainty when calculating these figures.

On the whole, economists and statisticians do their best with the quality of data available, and use methodologies they believe are best to calculate figures and make forecasts. That the numbers are usually off isn't necessarily a failure. The problem arises when the media and the public don't recognise that economists are not data gods.

One data point that seems to arouse more suspicion than most is the inflation rate, with many people usually referring to the price of an item they regularly purchase to discredit the reported figure. Does this make sense? 


Misleading Inflation Headlines

Let's illustrate this with October's inflation rate: 15.91% year-on-year according to the National Bureau of Statistics (NBS), compared to 15.98% in September. Can anyone at the NBS say with absolute certainty that the actual inflation rate was indeed 15.91% and not 16.09% or 15.89%? Hardly.

Statisticians are simply not able to make such precise calculations, a reality the public remains unaware of. In fact, October's inflation rate could be higher than September's – a 0.07 difference is not enough to honestly say. For this reason, many countries prefer reporting inflation to a single decimal place.

Meanwhile, actual changes in inflation do not amount to material changes in inflation. Understanding this, more reflective headlines would echo "no inflation change" not "inflation drops". 


Inflation Weights 

To understand why the reported numbers aren't perfect, consider a simplified version of how the inflation rate is calculated.

The NBS (and most countries) start by using data from consumers to determine what they spend their money on. Next, they put these items into broad categories to create a typical consumer basket – components include fruit, medical services, and air transport. The price change of these goods and services (740 in total Nigeria) is collected every month from across all states, and the final average price is calculated by adding up all prices using different weights. These weights are determined by the original consumer data that tells the NBS what we buy. If we spend most of our money on bread, then it will be given a higher weight and would have an outsized effect on the final inflation figure.  

There are some assumptions made during the process described. For example, it is assumed that all households experience the same change in the price within a product category. That's a fair assumption for goods like soft drinks but becomes an issue when we consider categories that have more differentiation. 

For example, "motor cars" – your inflation experience will depend on if you are an Innoson or Mercedes consumer. All countries make this same price change assumption nonetheless, and those in the statistics community are aware of it. However, consumers might not immediately realise that a reported inflation rate of 15.91% is very generalised and could be very different from what they experience. 

Inflation rates also vary by region. Bauchi's inflation rate In October was 23.87% whereas Abuja's figure was 13.23%. Yes, goods prices vary across states, but these numbers also differ because again people in different cities consume different goods and services, which will determine the final inflation figure for that state.

You can be sure that even within states inflation will vary – Lagos mainland vs. Lagos Island. 


What do you Consume?

So what you buy determines your inflation rate and the chances that the NBS knows what your individual consumption basket looks like are quite slim. Even more so because they use the Nigeria Living Standard Survey (NLSS) from 2003/2004 to determine what the typical Nigerian household is consuming. 

So while the previous problems with inflation rates discussed in this article are shared between all countries, the reliance on 2004 data makes Nigerian inflation rates less representative. The UK updates its consumption basket annually. This year it removed mobile handsets and added flavoured water as people buying smartphones and flavoured water has become a more common occurrence. 

2004 was a long time ago, and ideally, we would not be calculating inflation based on this data. More positively, the NBS rebased inflation calculations to November 2009, an exercise similar to the 2014 GDP rebasing. As we have argued before, governance by numbers requires trust, a realisation that Nigeria still grapples with. The NBS has been at the forefront of this charge, but equally important is that we all understand what statistics can and cannot do.

Then we can all agree that demanding a "true" inflation rate misses the point.


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