Monday, 26 January 2015

Price stability requires daily indexation

Price stability is an important concept in economics. It is defined in a slightly different way by each and every central bank. Each central bank defines price stability in terms of its own inflation target. When a central bank has a two percent inflation target then any inflation (which is NOT price stability) up to and including the inflation target is simply stated to be "price stability." For example: SA, US, EU, etc.

The South African Reserve Bank has a three to six percent inflation target. Thus, when the general price lievel changes by three percent per annum, then the SARB proudly states that "price stability" has been achieved and when it changes by six percent per annum, then the SARB again very proudly states that "price stability" has been achieved. The same is true for all other central banks with all their other non-zero inflation targets.

Monetary price stability has one and only one definition, namely, zero monetary inflation which is the same as zero monetary deflation.
However, price stability requires, in fact, at least daily indexation since sustainable zero monetary inflation (/deflation) has never been achieved to date.

There are three economic items in the economy:

1. Monetary items

2. Variable real value non-monetary items

3. Constant real value non-monetary items

Variable real value non-monetary items are by definition not generally expected to be stable in price in free and open markets. For example: the price of oil, gold, foreign currencies, listed and unlisted shares, smart phones, TVs, computers, cars, planes, ships, horses, cows, sheep, clothing, food, houses, etc are not generally perfectly stable in free and open markets.

Constant real value non-monetary items´ prices (constant real values or constant purchasing power) are kept perfectly stable (constant) in real value (purchasing power) under the IFRS and US GAAP authorized Capital Maintenance in Units of Constant Purchasing in terms of the Daily CPI accounting model by means of at least daily indexing.

Examples of constant real value non-monetary items are salaries, wages, fees, employee benefits, pensions, trade debtors, trade creditors, all other non-monetary payables, all other non-monetary receivables, issued share capital, profits, losses, all other items in shareholders´ equity, provisions, taxes, interest received, interest paid, etc.

Monetary items constitute the money supply. 

Monetary items´ (excluding fixed nominal value bank notes and coins) prices are also kept perfectly stable (constant) in real value (purchasing power) under CMUCPP in terms of at least the Daily CPI when the entire money supply is indexed at least daily.

Examples of monetary items are monetary loans receivable and payable, the capital amounts of bonds, the capital amounts of mortgages, the capital amounts of student loans, the capital amounts of consumer loans, etc. Nominal value bank notes and coins are also monetary items but it is currently not possible to daily index a nominal bank note or coin.

Thus: price stability requires at least daily indexation during inflation or deflation.

In short: price stability requires daily indexation.

All changes in the general price level have to be followed by monetary item and constant real value non-monetary prices if price stability (constant real value/purchasing power) were to be achieved in these items. The general price level changes daily (see the Daily CPI in countries issuing daily inflation-indexed government bonds) during low and high inflation and deflation, but it can change more than once a day during hyperinflation.

Nicolaas Smith

Copyright (c) 2005-2015 Nicolaas J Smith. All rights reserved. No reproduction without permission.

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