Constant Price Estimates

Expert Group Meeting on National AccountsCairo May 12-14, 2009

Presentation points

May 13, 2009

Why national accounts statistics are compiled?

Meet the needs of various users

Mainly

Government

Private analysts

Policy makers

Decision takers

May 13, 2009

What is the major use of national accounts statistics

Assess how a country’s economy is growing over time

Study the behavior of an economy at various stages in the economic cycle

The changes in current price estimates over time represents combination of

Change in prices Change in the underlying volumes

May 13, 2009

Are national account aggregates at current price estimates enough?

Do not reveal real growth of the economy

The growth may largely reflect increase in prices of the produced commodities

Current price estimates have two dimensions? Price Quantity

What is needed?

Decomposition of value in terms of prices and quantities for various commodities

May 13, 2009

WHY DO WE NEED PRICE AND VOLUME MEASURES ?

To properly interpret the changes in nominal figures when relative prices and/or the general price level are changing

For goods and services this means that when the nominal value of goods and services transacted changes

> how much is due to changes in quantity? > how much is due to changes in the prices of the goods or

services?

For nominal income this means that when such income increases or decreases

> how much more or less of goods can be bought as a result of the

change?

May 13, 2009

The scope of price and volume measures in the system

Price and volume measures are required > to factor the changes in the values of goods and services into components reflecting changes in their volumes and prices

> measure the cash flows in real terms by deflating their values by price indices

The scope of the price and volume measures also includes:

Taxes and subsidies Trade margins Balancing items (value added, GDP) Compensation of employees Consumption of fixed capital Stocks of produced assets (inventories, fixed assets)

May 13, 2009

Price and Volume measures in the System of National Accountsmain issues

What is meant by price and volume measurement for these items and their components

What is the relationship between the current price value and the price and the volume measures for these items?

How to aggregate them?

How to obtain price and volume measures in practice?

May 13, 2009

Main SNA recommendation for price and volume measures

Ideal method:

Annually chained Fischer price and volume indices for GDP and its components

Second bestAnnually chained Laspeyres volume indices and Paasche price indices ORAnnually chained Paasche volume indices and Laspeyres Price indices

Note: When chain indices are compiled for output, intermediate

consumption and value added, they are not additively consistent

May 13, 2009

How are price and volume measurement for GD obtained?

Through price and volume measures for its componentsFrom the production approach:

for Value added by industry PLUSfor taxes less subsidies on products

From the expenditure approach:

for government final consumption expenditure PLUSfor households final consumption expenditure PLUSfor NPISH’s final consumption expenditure PLUSfor capital formation (and changes in invent.) PLUSfor exports MINUSfor imports

May 13, 2009

What is meant by value (s) at constant prices

It is the value(s) of a product(s) for the current period using its own price(s) from an earlier period (base year)

Values at constant prices are an aggregated volume measure, expressed in money terms and additive

They reflect changes in quantity and/or quality

May 13, 2009

Dose the choice of base year affect growth rates?

Yes

The underlying weights will be different in different years

Why?

The rate of price change is not the same for all goods and

services

May 13, 2009

The usefulness of constant price series depend on?

Extent of the rate of price divergence for the commodities in the measure

Extent to which the relative price weights of the base period differ from the price relative weights of other periods included in the series.

May 13, 2009

General Principles of Price and Volume MeasurementsWhat is meant by price and volume measurements for aggregates of goods and services

How in practice to obtain price and volume measures for these aggregates

How to aggregate over price and volume measures for sub-components to obtain price and volume measures for more aggregated items

May 13, 2009

Concept of Constant prices, price and volume indices

The current value of a single product i at time t can be expressed as

v i ,t = p i ,t * q i ,t

Value of this product can be expressed in market price of previous period and construct a time series where all transactions for the product are expressed in the price of a selected base period 0 as ( p i ,0 * q i ,t )

The current value of the same product can also be expressed as

v i ,t = ( p i,t /p i,0 ) * p i ,0 * q i ,t

May 13, 2009

Similar set of relationships can be established at aggregated

level between

The aggregated rate of change of the value at current prices, and a Paasche price index and a Laspeyres volume index, The aggregate value at current prices, a Paasche price index and the aggregate value measured at constant price

The aggregated "price" measure - a Paasche price index

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May 13, 2009

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Paasche price index

take the ratio of the value of output in current prices in year (t) to the value of output in year 0 measured in constant prices (prices of year 0) (and multiply it with 100 to convert to an index form) The ratio of any aggregate in current prices to the aggregate in constant prices yields an implicit Paasche price deflator

May 13, 2009

Constant price measures

Measure the monetary value of an aggregate

Where Each individual quantity is valued at its own prices in an earlier period

Means Period-to-period changes in constant price estimate for aggregated items

Reflect changes in the quantities of the different items

Aggregated Volume Measure

May 13, 2009

Constant price estimates are

Aggregated price measure is in monetary terms

Constant price data are additive

Convenient way of constructing aggregate volume measures

The change from the base period constitutes a Laspeyres volume index

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May 13, 2009

Relationship between value, price and Quantity indices can be established at an aggregated level

Alternative index formulae for price and volume measures The Laspeyres price index

Paasche output volume index

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May 13, 2009

The value of base year output at prices in the current period

The Fisher volume index

The Fisher price index

Value index = Price index times volume index

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May 13, 2009

Constant price could be derived according to three methods

RevaluationDeflationVolume extrapolation With the possible exception of hyperinflation situations constant price estimates derived through deflation can in general be expected to produce more accurate results than extrapolation with quantity indicators.The justification for this is that price relatives (pt/p0) generally display less variation than quantity relatives (qt/q0 )

According to the expressions in the mentioned indices

May 13, 2009

Concept of Gross value added at constant prices

Gross Value added (GVA) is a non-observable concept

It cannot be decomposed into a price and a quantity component Concept of value added at constant prices can be defined and

measured as:

Output at constant prices (minus) intermediate consumption at constant prices

The GVA of an industry j at current and constant prices can be expressed as

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May 13, 2009

Laspeyres "volume" index GVA in j-th industry can be defined as:Ratio of GVA of j-th industry in period t at constant prices &GVA of j-th industry in the base year at the base year prices

Paasche "price" index for GVA of the j-th industry can be defined as Ratio of GVA of j-th industry in period (t) at current and constant prices

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May 13, 2009

Gross Value added at constant prices

Measure of the contribution of an individual production unit, or a group of production units, such as an industry, to the total output at constant prices of goods and services available for final use in the economy (consumption, capital formation, and net export).

A change in value added at constant prices can mean no more than a change in value added measured at some fixed set of prices and has no physical counterpart in the real world

May 13, 2009

Alternative price and volume measures for GVA

Paasche "volume“ index

Laspeyres "price index

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May 13, 2009

Concept of GDP expenditure at constant prices

GDP through the expenditure approach

Can be expressed as an aggregate of actually observed transactions

Recorded independently of the accounting framework

Have a physical counterpart in the real world

Can be factored into a price and a quantity component

The corresponding price and quantity index in principle being a weighted average of observable price and quantity relatives.

May 13, 2009

Methods of Obtaining Constant Prices GVA estimatesCountries develope alternative methods to derive constant

prices GVA

The developed methods depends on the choice of

Double or single indicator method Use of output or input related indicatorUse of extrapolation or deflation type of variable on which the indicators are based

All of them are variants of double indicator or single indicator methods

May 13, 2009

Since gross value added in current prices is derived indirectly as the residual item in the production account

> It has no observable flows of goods and services as counterpart, and

> No quantity and price components. Hence,

> It may not be revalued in the prices of a base year

Gross value added at constant prices is obtained as:

> the difference between the output and intermediate inputs

at constant prices - a process called double deflation

Double deflation

May 13, 2009

Double deflation means

output and intermediate consumption in current prices are deflated using an appropriate (Paasche type) price index, or extrapolated from base year values by an appropriate Laspeyres-type volume index

Double deflation is sensitive to error especially when

> input data are not accurate, and/or > value added is a small proportion of output

Double deflation

May 13, 2009

As approximation of double deflation, the volume index for gross output may be used to extrapolate the volume of gross value added when

> an index for intermediate inputs is not available or, > input data are not accurate

The underlying assumption is that

input-output coefficients are fixed so that price measures for intermediate consumption are derived implicitly

Alternatively, the Paasche price deflator for output may be used to deflate the value added data in current prices

The underlying assumption is that:

output and input prices do not diverge significantly

Single Extrapolation / Deflation

May 13, 2009

(i) Single Output related indicator methods: (a) Direct deflation of current price value added by a

producers’ price index (b) Direct extrapolation of base year value added using

a gross output volume index. (c) Direct extrapolation of base year value added using

indices based on physical quantity output measures.

Single Indicator Methods

May 13, 2009

(ii) Single input related indicator methods:Deflation current price GVA by price index of (IC).

Deflation of current price GVA by wage rate index

Extrapolation of base year GVA by volume index of (IC).

Extrapolation of base year GVA by index of deflated compensation of employees.

Extrapolation of base year GVA by index based on physical quantities of inputs other than labor.

Extrapolation of base year GVA by index of numbers employed.

Extrapolation of base year GVA by an index of man hours worked.

Extrapolation of base year GVA by index of hours and man-hours worked adjusted for change in labor productivity.

May 13, 2009

Normally,

The volume index for output is preferred to one based on inputs, which has greater bias because number and variety of outputs is smaller than the number of intermediate goods and services consumed in the production process commodity composition of inputs is more variable over time

Single Indicator Methods Cont….

May 13, 2009

Specific issuesTrade margins at constant prices :

The trade margin is calculated as the difference between the value of the goods sold valued at current purchasers' prices and at current producers' prices

The amount and value of the trade margin is not directly observable

Trade margins at constant prices cannot be estimated by deflating the trade margins at current prices directly

The constant price estimates of the margin can be defined as the difference between the value of the goods sold valued at constant purchasers' prices and at constant producers' prices

In practice: trade margin at constant prices is obtained by many countries by simply extrapolating total trade margins in the base year with a volume index for trade turnover

May 13, 2009

Specific issues ….. cont.

Taxes and subsidies on products at constant prices:

Do not have price and quantity components

Can not be estimated by deflating current estimates directly

Defined as the base year tax rate on the product multiplied by the value of the product at constant prices

In practice: constant price estimates can be estimated by:

> Applying the implicit base year tax rates on the relevant transactions at constant prices

> Extrapolating the base year value with volume indices for the relevant transactions

May 13, 2009

Constant price estimation in practice

Calculation of Passche price Indexes for all parts of the national accounts is not always possible – data requirement

The compromised solution is to deflate current price values at the most detailed level possible by Laspeyres deflators

The outcome of this solution is an approximation of the results which would have been achieved by using Passche deflators

This solutions is generally satisfactory provided that the relative quantities and/or relative prices of each item do not change significantly over time

However, it is rare for such conditions to be met in practice

What to do?? Revalue commodities causing problems separately from all other

commodities so that the price deflators have the most up-to-date weights possible ???

May 13, 2009

The major problems

Most of the price indices are compiled using the Laspeyres formula

The base periods for some of the price indices differ from the base year chosen for the national accounts

The weights used in compiling the available Laspeyres price indices are not updated regularly

The compilation level might not be adequate to obtain an approximation for Paasche price and Laspeyres volume indices

May 13, 2009

What to do??Improve the compilation level to be at more disaggregated level? How?

Do not use single deflators?

Improve the price statistics?

Update the weights of price indices regularly? When?

Improve the level of details in the current price estimates?