Wednesday, July 22, 2009

Deflation? What Deflation?

Today's CPI report from DOS brings some positive news: inflation is back, albeit very mildly. Don't pay any attention to the year-on-year number (log annual change; 2005=100):

Disinflation was always on the cards after last year's runup in petrol prices. What matters now is that the price level appears to have stabilised:

And monthly price level changes are positive for the second month running, the first time that has happened since last August (log monthly change; 2005=100):

Why is inflation at this juncture positive news? Because it signals recovery in domestic demand. To underscore this point, rising prices in June are not due to food or petrol price increases but is rather more broadly based.

To check this I stripped the (volatile) food and transport categories out of the CPI, which leaves an approximate measure for "core" CPI. In retrospect, looking at the core inflation trend shows that Malaysia was in little danger of a deflationary spiral this year (log annual changes; 2005=100):

Mea culpa - I should've done this earlier. I'm going to try and extend the core measure back as far as I can, and it will probably force me to reassess BNM's monetary policy moves as well as real interest rate measures. The lower core inflation indicates that monetary policy is in fact tighter pre-2009, and looser this year, than I thought it was.

Technical Note:
I used an arithmetic average of the remaining weights after stripping out Food (31.4%) and Transport (15.9%). That approach is probably questionable - I prefer using geometric averages when I can, but time constraints did not permit. Plus stripping away what amounts to half the CPI is also grounds for caution - but the core measure does explain why BNM was relatively unmoved by the commodity bubble of 2006-2008, so I'm going to keep calculating this and see where it leads.

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