INFLATION IS DROPPING BUT THE PRICE OF BREAD DIDN’T GET THE MEMO.
Author’s note: My inflation calculations were on a month-on-month basis (i.e. comparing Jan’22 to Feb’22). That means I calculated monthly inflation, not the annual inflation that is typically reported by the NBS. Annual inflation is (Jan’22 versus Jan’21)
I am currently laying in bed, listening to a podcast that my family friend guest-featured on and I find the topic very interesting. I previously had the idea to write on inflation a.k.a my favourite macroeconomic topic ever — so, listening to the podcast increased my ginger, hence why I’m typing this.
For the past few months, I have been reading reports on how inflation is reducing yet the last time I went to buy eggs, I was told one egg now sells for N80 (true story, I was shook). Makes no sense but there is a sensible explanation, however. The reason? BASE EFFECT.
Let’s start with what that word is in general before I dive a bit further into how this base effect is playing out in Nigeria right now.
Base effect in proper English is the “effect” that your basis of comparison has on your result. When you have a smaller basis for comparison, your answer will seem larger than it really is. But when you compare with a bigger base, it shrinks your result.
Let’s use numbers:
10/2 (with 2 being your base) equals 5.
10/4 equals 2.5.
It’s the same number 10 but the smaller base gives a larger result.
“How this one take concern the rising cost of Titus sardine?” you may ask.
Inflation and Base Effect
Inflation rate in Nigeria is calculated by statisticians that work at the National Bureau of Statistics (NBS). They use a measure called the Consumer Price Index (CPI).
CPI essentially is the weighted average of prices of a basket of goods and services used to represent the general price level in the economy.
In simpler terms:
Let’s say NBS guys want to know the average price level of goods in Lagos. Instead of going around Balogun market, asking for the price of all the things they’re selling and writing it down to get the average, they just select some goods to form their basket. There are important goods and services that are essential to everyone: Bread, eggs, coffee/tea, transportation, healthcare etc. When the prices of these items are going up, then it is a good indication that things are getting expensive in the country.
The average price level that they are trying to calculate is called the CPI.
So, let’s assume CPI for December 2020 was N250.
Now when calculating the CPI for January 2021, the NBS guys go around and ask for the prices of essential items in their basket. Let’s say the average price (CPI) for January was about N265.
Therefore, inflation rate in January is 6%.
Using the same formula, we assume NBS guys go around again in February to gather the prices of goods and the average price (CPI) is N350.
Within the space of one month, inflation jumped by 26%
Now going back to the market in March, the average price (CPI) is N370.
Therefore, inflation rate for March using that same formula is 5.7%.
So inflation rate has dropped from 32% in February to 5.7% in March (unrealistic in the actual sense). But note, the average price (CPI) still went up by N20 from N350 to N370 in March, meaning prices are still increasing.
This shows that prices rose faster in February from N265 to N350 which led to high inflation and it rose yet again in March but slower from N350 to N370 which led to inflation falling drastically.
When comparing N350 to N265 in the first scenario, our result was high inflation. But when comparing N370 to a larger number i.e N350, our result was lower inflation. Base effect has played out. Prices are still rising but due to the high base figure, it gives an illusion that inflation has dropped.
Let’s look at a more recent scenario that happened in the economy last week.
GDP and Base Effect
These same NBS guys released the GDP report for the third quarter of 2021 (Q3 2021) showing us the economic performance so far.
*Q1 measures from January to March
* Q2 measures from April to June
* Q3 measures from July to September
GDP is a measure of the total value of goods and services produced in an economy. It shows the level of productivity of the residents of a country and how much they made. When you compare the GDP for this year to the GDP from last year, it gives an idea of how much the economy has grown within a year.
Now an example of how base effect has played out in Nigeria’s GDP growth.
True story: Nigeria’s GDP grew by 1.87% in Q1 2020. That was the start of the year before Covid hit. After Covid hit, the economy grew by -6.1% in Q2 2020 (negative growth meaning we produced less than the year before). Again, in Q3 2020, another negative growth of -3.62%. So we had two negative growths back to back meaning we fell into a recession.
Let’s move to 2021. In Q1 2021, that’s the beginning part of the year, the economy grew by 0.51% meaning we produced more in Q1 2021 compared to back in 2020.
Then in Q2 2021 we saw this.
I can imagine this was his face when he saw the growth rate.
They really thought they did something.
Yes, the economy did grow by 5.01% but how did it jump from 0.51% in Q1 2021? Did we produce so much more in Q2?
If you scroll up a bit, you’ll see where I mentioned that Covid hit us in the second quarter of 2020 and we had -6.1% negative growth. When you compare a just alright egg to a bad egg, it seems like a very good, golden egg. If the Q2 2020 GDP numbers had not been negative, the 2021 GDP rate wouldn’t have been as high as 5.01% but the base was too low (-6.1%) which led to an illusion of HOOOGE economic growth (the economy did grow, no arguments there. Just not so much).
The same thing happened in third quarter of 2021 and as proof that it was all base effect all along, the economy grew by 4.03%, less than second quarter. One of the reasons being that Q3 2020 didn’t perform as bad as Q2 2020. In Q3 2020, the economy only fell by -3.62% (Q2 was -6.1%). So when comparing it to the current GDP one year later, the growth rate didn’t come up as strong.
I hope that summarizes what base effect is all about.
Thank you for reading so far! If you still have questions, send me an email on khadijatbabatunde1@gmail.com or a DM on WhatsApp if you have my phone number. See you next time! xx
