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Saturday, 26 February 2011

What price stability?

“The South African Reserve Bank is the central bank of the Republic of South Africa. It regards its primary goal in the South African economic system as the achievement and maintenance of price stability.

The South African Reserve Bank conducts monetary policy within an inflation targeting framework. The current target is for CPI inflation to be within the target range of 3 to 6 per cent on a continuous basis.” SARB.

Absolute price stability is a year-on-year increase in the Consumer Price Index of zero percent. Alan Greenspan defines price stability as follows:
“Price stability obtains when economic agents no longer take account of the prospective change in the general price level in their economic decision-making.”
http://www.kansascityfed.org/PUBLICAT/SYMPOS/1996/pdf/s96green.pdf

, Page 1.

It can be deduced from Mr Greenspan´s excellent definition that price stability can be defined as permanently sustainable zero per cent per annum inflation.

A year-on-year increase in the CPI of above zero but below 2% is a high degree of price stability – it is not absolute price stability.

“The ECB´s Governing Council has announced a quantitative definition of price stability:


Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.


The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.” European Central Bank

http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html

A below 2% year-on-year increase in the European Monetary Union’s harmonized CPI is the European Central Bank’s chosen definition of price stability. It is not the factual definition of absolute price stability. Theoretically, the SARB´s chosen definition of price stability is for “inflation to be within the target range of 3 to 6 per cent on a continuous basis”.

Accountants, on the other hand, solve the problem of the fact that the monetary unit is never perfectly stable on a sustainable basis by simply assuming that the monetary unit is perfectly stable in the world´s low inflationary economies, but, only for the purpose of valuing balance sheet constant real value non-monetary items and most income statement items which they account as Historical Cost items: they measure them in nominal monetary units. In conformity with world practice they do not apply this assumption to the valuing of certain Income Statement constant real value non-monetary items, namely salaries, wages, rentals, etc. which they inflation-adjust annually in terms of the CPI. They value other income statement items in nominal monetary units, i.e. at HC.

Accountants do not regard changes in the general purchasing power or real value of the monetary unit to be sufficiently important to continuously measure financial capital maintenance in units of constant purchasing power as they have been authorized by the IASB in the Framework, Par 104 (a) in 1989. They generally choose to implement financial capital maintenance in nominal monetary units, also authorized by the IASB in the Framework, Par 104 (a). It is impossible to maintain the real value of existing constant real value capital constant by measuring financial capital maintenance in nominal monetary units per se during low inflation or deflation. Financial capital maintenance in nominal monetary units per se during inflation and deflation is a fallacy.

This led accountants to choose to implement the traditional Historical Cost Accounting model during non-hyperinflationary periods where under they select to maintain the stable measuring unit assumption (also IASB-approved and also based on a fallacy) for an unlimited period of time during indefinite inflation. They value both variable real value non-monetary items stated at HC in terms of IFRS or GAAP, as well as constant real value non-monetary items also stated at HC in terms of the HCA model, in nominal monetary units during non-hyperinflationary periods. Both HC variable and HC constant items are thus considered by accountants to be simply HC non-monetary items.

There is a fixation in accounting that measurement in units of constant purchasing power (restatement) simply means adjusting company financial statements mainly to make current year statements more comparable with previous year statements. Measurement in units of constant purchasing power is not automatically thought of as affecting the fundamental values of the underlying resources although that is what is done with world wide annual measurement in units of constant purchasing power of salaries, wages, rentals, etc. The two processes are seen as different processes - when they are not.

Copyright (c) 2005-2011 Nicolaas J Smith. All rights reserved. No reproduction without permission.