How is inflation calculated?

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How is inflation calculated?

The Consumer Price Index is calculated by comparing the month-to-month price of a basket of approximately 600 goods and services grouped into eight categories.

In Canada, inflation is measured by Statistics Canada, a federal government agency founded in 1971. (Archive)

The measure of inflation released each month by Statistics Canada is the result of the work of a hundred analysts and constant international cooperation. It is also the product of a century of methodological choices that all have an impact on this indicator scrutinized by the public as well as by economists and politicians.

In Canada, the Consumer Price Index (CPI) is the most common measure of inflation. Calculated since 1914, the CPI was initially used to settle wage disputes that emanated from the rapid loss of purchasing power of workers at the beginning of the 20th century.

Today, in addition to providing an anchor for the adjustment of many payments such as salaries and rents, the CPI is used to index certain retirement pensions and several government programs.

The Bank of Canada, for its part, adjusts interest rates according to inflation in the country, which it tries to keep within a range of 1% to 3%.

In December 2021, the federal government and the Bank of Canada agreed to maintain the annual inflation target at around 2%.

The CPI is calculated by comparing the month-to-month price of a basket of approximately 600 goods and services grouped into eight categories. This basket includes everyday consumer products, such as laundry detergent, but also more unusual goods and services such as the cost of a game of bowling, for example.

To construct the index, Statistics Canada assigns a relative weight to each product based on the consumption habits of Canadians.

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We cannot observe the price of all products, so we resort to a representative sampling of goods and services, whose prices are collected in a representative sample of stores, explains Clément Yéloux, economist and senior analyst at Statistics Canada. /p>

If the principle is simple, its application presents many challenges.

Florence Jany-Catrice, professor of economics at the University of Lille, France, points out the complexity of evaluating price increases that affect several million people who have distinct consumption habits to arrive at a single measure.

It is the great magic of macroeconomic figures: to succeed in providing a single figure to account for a multiplicity of price variations, explains the French economist who has published several works on the CPI and its calculation.

While historically most prices were collected manually by agents dispatched across the country, the pandemic has accelerated the shift to more digitized collection methods.

Mr. Yéloux highlights the change in approach orchestrated in March 2020. We no longer had access to the stores, and […] we could not take the risk of not calculating the CPI, so we had to change our habits to adapt to the situation, he recalls.

The windows of a business in Ottawa are covered with newspapers during the COVID-19 pandemic . (Archive)

Statistics Canada estimates that before the pandemic, half of the prices used in the calculation of the CPI came from traditional field collection. Today, prices are obtained almost entirely online or from alternative collection methods.

Among alternative collection methods, Statistics Canada says it derives an increasing proportion of its data from merchant scanners, i.e. prices recorded by retailers at checkout.

This avenue will substantially increase the price sample of the statistical agency in the coming years. Provided a product was purchased in-store by a consumer in a given month, it will appear in our calculations, Yéloux argues.

If Statistics Canada hopes to increase the accuracy of its calculations, this collection method also brings a new way of evaluating the quality of products.

To calculate the CPI, the statistical agency says it evaluates a basket of goods and services of consistent quantity and quality.

Thus, when the quality of a product changes from month to month, analysts adjust the price change of the product to reflect inflation only, and not the price increase related to the change in quality.

For example, analysts could reduce the price change of a coat that its manufacturer has made more waterproof in the last month. The same is true for a product that has decreased in volume, especially food.

“Reduflation” is a marketing strategy that involves reducing the size of products, rather than increasing prices. (Archive)

This work was historically done by price collectors who collected prices in stores. In the event that this work is superseded by cash register data, Statistics Canada must rely on information provided by retailers.

Sonya Chartrand, Head of Price Unit at the consumption at Statistics Canada, also indicates that the current collection methods, in particular online collection rather than in-store surveys, could be reviewed in the coming years. It recalls that the methodologies for calculating the CPI are constantly evolving.

If the calculation of inflation requires the analysis of a basket of goods and services that is relatively stable over time, this indicator is only relevant if this basket is representative of the consumption habits of Canadians.

This means that Statistics Canada must occasionally modify the products that make up the CPI.

Thus, over time, coal, woolen blankets and knitting yarn gave way to Internet access services, cell phones and recreational cannabis, for example.

Recreational cannabis added to IPC product list in 2019, following its legalization in Canada. (Archive)

However, the statistical agency does not add every new product that enters the market. In general, we are waiting for [evidence] that the product has gained importance in consumer spending [to include it in the CPI], explains Mr. Yéloux.

Several products require a suitable method to measure its price changes.

The Statistics Canada analyst presents the example of airline tickets . Their value constantly fluctuates depending on several variables, which makes measuring their price particularly difficult.

To respond to this difficulty, the statistical agency has been using transaction data recorded by tour operators for two years. Thus, Statistics Canada includes in its inflation calculation the price of a large proportion of the tickets purchased by Canadians in a given period. Just that, it gives rise to millions of prizes, argues Mr. Yéloux.

To calculate the CPI, Statistics Canada assigns a different weight to each of the products evaluated to reflect the consumption habits of Canadians.

For example, variations in the price of milk have a plus weight in the index than those of pickled olives, which occupy a lower place in the average grocery basket.

These weightings are reviewed periodically by the statistical agency. But again, the pandemic required changes in methodology.

Consumption habits have changed a lot in 2020. We felt that using 2019 data to introduce new weightings from January 2021 was not appropriate, explains Yéloux.

In response to rapid changes in the Canadian economy, Statistics Canada updates its weights annually, rather than every two years as it used to.

Ms. Chartrand notes that this practice could also be called upon to change.

Since the CPI is used to compare inflation in different countries, several international economic agencies, including the United Nations and the International Monetary Fund (IMF), impose certain standards on its calculation.

These agencies also outline best practices for measuring inflation, recommendations that Statistics Canada says it strives to follow.

According to the IMF, the world economy will contract by 4.9% this year, a decline worse than the 3% mentioned in april.

The Canadian statistical agency has also set up an advisory committee made up of experts from different countries to which it submits its major methodological changes for approval.

At the same time, Statistics Canada says it is in constant collaboration with international partners. Yéloux says his team meets with UK and US statistical agencies every month to discuss how different components of the CPI are calculated.

Despite this international collaboration, Ms. Jany-Catrice explains that there will always be differences in the calculation of inflation from one country to another. It recalls that these methods will always have to evolve.

Transformations in the ways of consuming and producing are happening much faster than official statistics, which themselves need a bit of stability [to calculate inflation], she argues.

Official statistics run behind realities that are constantly changing, adds the economist. She believes that there will never be a perfect way to calculate inflation, but that in her view statisticians do the most rigorous job possible.

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