Why Hong Kong’s Inflation Rates Can Keep Low?
[Youtube video at https://youtu.be/WN4iT5oAEvk]
Many countries around the world have been experiencing rapid growth in inflation rates in 2021. The United States recently announced that the inflation rate continued to climb to 6.8% in November, the highest record since June 1982. The Federal Reserve Board has just announced that it will raise interest rates three times before the end of next year (Reuters, 2021).
This may remind many seniors of the “The Great Inflation” period in the 1970s and 1980s (Bryan, 2013), when inflation rates in the United States rose above 14% in 1980 (Figure 1), part of the reason is related to the termination of the quasi-gold standard (Yiu, 2021a).
International inflation rates rise sharply in 2021
In 2020, the world was hit by the pandemic and the global economy suffered a severe setback. Countries once fell into economic recession and deflation. But then when the central banks took a concerted action of cutting interest rates to historical lows and other money easing measures, recessions were turned to economic growth.
However, when a strong global economic growth encounters a broken supply chain in the world due to the pandemic, prices of various raw materials, fuels, food and many other types of goods are rising fast. CPIs (Consumer Price Indices) follows PPIs (Production Price Indices). It can trigger a supply-push stagflation.
Figure 2 shows the PPIs of Canada (CAN), Germany (DEU), France (FRA), the UK (GBR) and the US (USA). The strong growths of PPIs started in the midst of 2020, and CAN and USA in particular recorded almost 15% increase so far.
Figure 3 shows the inflation rate of the five countries from July 2015 to the June 2021. Corresponding to the PPI chart in Figure 1, CAN and USA also recorded the strongest increases in inflation rates, of about 3–5%, and the latest released inflation rate of the US in November 2021 is 6.8%, showing that the upward trend continues. The Federal Reserve Board stops describing the inflation as transitory.
Compared with these OECD member countries, Hong Kong’s inflation rate is relatively moderate, only 1.7% in October 2021, and there was even a deflationary period in 2020. The deflation rate in July and September 2020 were -2.3% and -2.2% respectively. In contrast, the inflation rate of Hong Kong in 2019 was higher than that of the five countries (Figure 4).
Reasons for a lower inflation rate in Hong Kong in 2021
To understand the causes of a more severe deflation in 2020 but a milder inflation in 2021 in Hong Kong, we must understand how inflation rate is calculated first. According to the website of the Hong Kong Census and Statistics Department,
“The year-on-year rate of change in the CPI is widely used as an indicator of the inflation affecting consumers.” and “The Consumer Price Index (CPI) measures … the price level of consumer goods and services generally purchased by households.”
Regarding the price survey of consumer goods and services, the Census and Statistics Department regularly counts the prices of 920 goods and services based on the nine categories of consumer goods and services. As shown in Figure 5, expenditure weights are imposed on the categories based on the proportions of household expenditures collected from the survey.
Due to the unique socio-economic situation of Hong Kong, residents spend more than 40% of their expenditures on housing rents. It therefore makes the inflation rates measured in Hong Kong highly dependent on the changes of housing rents.
On the contrary, it puts relatively low weights for various other types of expenditures. For example, food prices have been increasing substantially in recent years, but since the category of Basic Food only accounts for about 10% of the total weight, its price changes will only slightly affect the inflation rate.
It must be noted that housing price is NOT counted in estimating the consumer price index, only housing rent is considered as consumer goods and services generally purchased by households.
Illustration 1: The impact of doubling pork prices on inflation
For example, Figure 6 shows that the price of pork that has doubled since 2019, but the inflation rate in 2020 was negative. The reason is that pork is classified under the Basic Food category with an expenditure weight of the composite consumer price index of only 10.36%. Furthermore, pork is just one of the 26 basic food items with a net expenditure weight of only 1.35%. In other words, even a 100% increase in pork prices will only contribute to the inflation rate by less than 1.5%.
Illustration 2: The impact of a 10% drop in rents on the inflation rate
On the contrary, Figure 7 shows that Hong Kong’s residential unit rents have been rising at a rapid rate until mid-2019. In May 2017, it rose at an annual rate of 10.5%, and only started to fall in mid-2019. By August 2020, the rate of decrease was -9.5%, and then slowly slowed down. The trend is highly similar to the Hong Kong inflation rate in Figure 4.
The reason is that the weight of housing rents in the consumer price index is as high as 40%, and there are only two sub-category under housing rent category, they are private rental housing and public rental housing. The net weight of private rental housing is as high as 35.46%. In other words, a 10% decrease in rent can cause the inflation rate to fall by 3.55%!
However, since most Hong Kong residents are not private housing tenants, so their perception of price increases of consumer goods and services may not be the same as the inflation figures released by the government. In fact, prices of many types of daily necessities are soaring due to the pandemic, residents are mostly stressful by the increase in living expenses, but the government’s release of the monthly inflation rate in October 2021 was only 1.7%! ? Employers usually refer to the inflation rate to determine the salary increase rate, and thus the quality of life of employees may decline as a result of the over-weight of housing rents.
References:
Bryan, M. (2013) The Great Inflation, 1965–1982, Federal Reserve History. https://www.federalreservehistory.org/essays/great-inflation
Reuters (2021) Fed signals three rate hikes coming in 2022 as inflation battle begins, Dec. 16. https://www.reuters.com/markets/us/fed-prepares-stiffen-inflation-response-post-transitory-world -2021–12–15/
Yiu, C.Y. (2021a) 50-Years of Fiat Money, Medium, Nov. 14. https://medium.com/discourse/50-year-of-fiat-money-9cf0d15a489f
