Understanding Inflation and Revising National Price Data

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Understanding Inflation and Revising National Price Data Understanding Inflation and Revising National Price Data By: Rima Turk Ariss Report Type: Research Study December 2012 Published by: Lebanese Economic Association Beirut- Lebanon 105541 Upgrading Lebanon’s Economic Analytical Capacity Lebanon Lebanese Economic Association Piccadilly Center, Suite 308, Hamra Street, Beirut- Lebanon The research team comprised of Ariane Kesrouani , Nabil Abdo, Ali Dirany, Carole Kerbage, and Pierre Mouganie The research team can be contacted on: [email protected] *This report is presented as received from project recipient(s). It has not been subjected to peer review or other review processes. *This work is used with the permission of Lebanese Economic Association *Copyright © 2012, Lebanese Economic Association Abstract: Lebanon is a small dependent economy with extreme vulnerability to external price shocks; yet no inflation targeting policy or good knowledge on price evolutions is available. The quality of statistics is hampered by severe technical problems as well as an acute shortage of human and material resources. This research study exposes the need for revising national price data in Lebanon especially after a recent wage adjustment episode revealed the lack of agreement on the magnitude and causes of inflation, and the predominance of political considerations when undertaking economic decisions in addition to the absence of a robust framework to monitor price increases and enforce compliance. This study starts with contextual evidence, and then proceeds to review the theory of indices, followed by conceptual and operational issues in the CPI. It also surveys available price statistics in Lebanon and uses STATA to perform consistency and validity checks through regression and correlation analysis. The main findings of this analysis reveal a strong positive correlation between domestic & international inflation rates, and that several components of CPI do not capture reality. The study concludes with proposals for food-imports and real estate price indices to improve price monitoring and inflation targeting in Lebanon. *Keywords: Inflation, price index, CPI, data and statistics, Lebanon, price monitoring, cost of living, inflation targeting policy -1- ACKNOWLEDGEMENT This report is the output of the project: Upgrading Lebanon’s Economic Analytical Capacity, which was supported by the International Development Research Center- Canada between June 2010 and December 2012. The project aimed to upgrade Lebanon’s economic analytical capacity by focusing on key economic and social issues facing the Lebanese society. The project empowered key public officials with the necessary skills and tools to actively engage in tackling current issues, and contribute to putting them at the center of the public policy debate scene. The project focused on two central public policy issues: 1) promoting economic stability by tackling inflation and 2) safeguarding social security and medical care for the elderly through pension reform. Thus, the project established relationships with several related public entities including ministries and public institutions, who in turn selected their representatives. These public officials were divided into two thematic working groups and underwent training, research, regular workshops and seminars to participate in the write-up of the final reports and to engage in the suggested reforms. The report was written by Rima Turk Ariss, Ph.D. (Associate Professor of Finance at the Lebanese American University and Project Working Group Coordinator for Inflation) on the basis of inputs and research done with the excellent support of several research assistants including Ariane Kesrouani , Nabil Abdo, Ali Dirany, , and Pierre Mouganie. The project team would also like to acknowledge the valuable comments of Prof. Alban Thomas and appreciated inputs of working group members Mireille Mouawad, Cathrina Antoun, Ali Daher, Mazen Baba, Nader Keirouz, Najwa Yaacoub, Rayan Dandache, Razi ElHage, Roula Awad. For more information about this project, you can visit www.leb-econ.org or contact LEA: Tel: +961.1.74 80 20 E-mail: [email protected] -2- OUTLINE Chapter Title Page Chapter 1 Inflation and Wages Adjustment in Lebanon a) Background 5 II- Lessons Learned 6 b) Lack of Agreement on the Magnitude and Causes of Inflation 6 c) Revival of the Price Index Committee and Expanding its 9 Inclusiveness 10 d) Introduction of the Social Wage Concept e) Predominance of Political Considerations when Undertaking 11 Economic Decisions f) Absence of a Robust Framework to Monitor Price Increases and 12 Enforce Compliance Chapter 2 General Introduction to the Theory of Indices g) Introduction 15 II- Historical Overview of Price Indexes 17 III- Conceptual Framework 19 IV- Major Price Indexes 22 a) The Consumer Price Index (CPI) 22 b) The Producer Price Index (PPI) 24 c) The Export/Import Price Index 25 d) The Real Estate Price index 26 e) The GDP Deflator 26 V- Common Price Index issues 27 Chapter 3 Conceptual and Operational Issues in the Consumer Price Index (CPI) I- Introduction -3- II- Sampling and Collection methodology issues in the CPI 31 III- Non- Sampling bias (errors) in the CPI 32 a) New Product Bias 35 b) Substitution Bias 35 c) Formula Bias 37 d) New outlet Bias 38 e) Quality Change Bias 41 f) Time of Month Bias 42 IV- Concluding Remarks 44 44 Chapter 4 Survey of Available Price Statistics in Lebanon, with Consistency and Validity Checks 47 I- Introduction II- Central Administration of Statistics (CAS) CPI 48 a) Overview 48 b) Methodology 50 c) Recent Trends 51 III- Consultations and Research Institute (CRI) CPI 53 a) Overview 53 b) Methodology 54 c) Recent Trends 56 IV- Ministry of Economy and Trade Food & Beverage (MOET) Price Index 57 a) Overview 57 b) Methodology 59 c) Recent Trends 61 V- Chamber of Commerce and Industry of Beirut (CCIB) CPI 62 VI- Consistency and Validity Checks 63 -4- a) Consistency among Domestic Inflation Rates 64 b) CPI Discrepancy: CAS vs. CPI 65 c) Domestic vs. International Inflation Rates 67 d) Domestic vs. International Food Inflation Rates 70 e) Domestic vs. International Energy Inflation Rates 71 Chapter 5 Proposals for New Price Indices I- Food Imports Price Index 75 II- Real Estate Index 78 Appendix A- Wage Adjustment Decree No. 7426, January 18, 2012. 87 Appendix B- Comparative Tables of All Proposals to Government 89 Appendix C- Construction of the CPI index 92 Appendix D- The Boskin Report 93 Appendix E - UN's Classification of Individual Consumption by Purpose 94 (COICOP) Appendix F - CAS Price Adjustment for changes in features of a good in the CPI 96 Basket Appendix G- CRI Expenditure Groups 97 Appendix H- Agro-food Sections of the Harmonized Commodity Description and 98 Coding System (HS) -5- Chapter 1 Inflation and Wages Adjustment in Lebanon I- Background 5 II- Lessons Learned 6 a) Lack of Agreement on the Magnitude and Causes of Inflation 6 b) Revival of the Price Index Committee and Expanding its Inclusiveness 9 c) Introduction of the Social Wage Concept 10 d) Predominance of Political Considerations when Undertaking Economic Decisions 11 e) Absence of a Robust Framework to Monitor Price Increases and Enforce Compliance 12 -6- I. Background Following the end of the civil war and the stabilization of the domestic currency by the central bank, the first wages adjustment process took place in 1996, and a unique amendment in 2008 granted a lump sum increase of LBP 200,000 per month for both public and private sectors employees, bringing the minimum wage up to LBP 500,000 from LBP 300,000.1 For the next sixteen years, however, there were no wage increases even though inflation kept rising and reached a hundred percent and the purchasing power of the Lebanese people started to drop significantly.2 In a study conducted by the Lebanese Federation of Consumer Protection, Lebanon was ranked first amongst 14 Arab countries in terms of high prices for meat, sugar, tea, and milk, and it ranked second when it came to tomato, potato, and vegetable oil prices. The study attributed these results to the presence of poorly competitive consumer markets (monopolies), and to the non- enforcement of regulations related to fixing commercial profit margins.3 These factors and others have contributed to a significant decrease in the share of wages in the Gross Domestic Product, which some entities claim to have reached a low of 30%.4 By mid of 2011, talks started mounting about the low level of wages that is preventing Lebanese workers from satisfying their basic needs in light of rising food prices and the cost of basic services like electricity and transportation. Indeed, the issue of wages adjustment became one of the top priorities on the public scene over a five-month period between September 2011 and January 2012. These talks were initially favored by a “political opportunity” that was materialized by the formation of a new government in July 2011 and which declared placing social justice 1 Abou Zaki, Racha. “Simmering wages adjustment”, August 25, 2011. Al-Akhbar. 2 Wehbe, Mouhamad. “Fixing the wages adjustment claim”, July 23, 2011. Al-Akhbar. 3 “Lebanon, first amongst 14 Arab countries in high cost of some food items”, August 26, 2011. Al-Hayat 4 Wehbe, Mouhamad. “Fixing the wages adjustment claim”, Id. -7- amongst its priorities.5 They were also timely because of the approaching of the new academic year that entails along the burden of rising school and university tuition fees. The process started with a dialogue among various concerned parties, including the Presidency of the Council of Ministers, the Ministry of Labor, economic bodies, and labor unions. However, the debate escalated into a conflict that threatened the unity of the government before culminating in the adoption of the wage adjustment decree No. 7426 during the January 18, 2012 session of the Lebanese Cabinet. This section summarizes the major lessons learned from the wages adjustment discussions on the economic and political fronts from mid-2011 to mid-2012.
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