Estimating National Accounts Aggregates at Constant Prices - Preferred Methods UN-ESCWA 22 – 25 September 2007 Cairo

2 Why Estimates at Constant Prices? The changes in the current-price estimates embody change in prices and underlying volumes - not suitable for assessing performance of an economy over time. Constant-price estimates (or Volume Measures) help assess “how a nation's economy is changing over time in real terms”.

3 What are Constant-Price Estimates? Changes over time in values of flows or stocks of goods and services can be factored into two components – –One, reflecting the changes in prices –Other, reflecting the changes in volumes The changes in volumes are measured as changes in the values of national accounts (NA) aggregates at constant prices –Conventionally, refer to prices in the ‘base’ year.

4 Which NA Aggregates? Constant-price GDP estimates are the most commonly used measures of real growth. But can be estimated by –production, expenditure and income approach –all of which are required to be the same There are other NA aggregates of interest like GNI per capita GNI, Final Consmp. Expd. and GFCF –These ought to be consistent with the GDP estimates as well as with each other. Thus, an integrated framework – SNA.

5 SNA Accounting Structure – Brief Overview [Please refer Handout-1] The accounts of SNA (except Balance Sheets and Other Changes in Assets Accounts) contain values of items involved in transactions –linked to production, income generation and distribution, consumption and capital formation. They are recorded in the following sequence of accounts: Current Accounts: Production account → Generation of income account → Allocation of primary income account → Secondary distribution of income account → Use of income account → Accumulation Accounts: Capital account and Financial account

6 Constant-Price Estimation - Main Aggregates (1) Direct measurement of all aggregates at constant prices not possible. Thus, –only a restricted set of aggregates –‘income’ aggregates only at the ‘total economy’ level and –selected items of external transaction accounts included in the list. [Please refer Handout-1]

7 Integrated Approach (1) At constant prices, GDP can be measured directly from ‘production’ and ‘expenditure’ sides. [See ‘Two Important Identities’, Handout-1] One unique measure of GDP volume requires full consistency between them. Use of the accounting framework –helps attaining consistency –permits the calculation of balancing items, in the same way as they are calculated at current prices.

8 Integrated Approach (2) Normally, the measurement of GDP volume growth is based heavily on only one of the two approaches. In most countries, data on household consumption expenditure are regarded as less reliable, thus ‘production’ approach is preferred. For a particular product, output data are more reliable and for another product the expenditure data. Thus, in general, the best result is obtained when the best of both approaches are combined. This can be achieved by using the same accounting framework as used in current prices.

9 General Principles GDP at constant prices can be measured –as sum of final uses at constant prices –As sum of GVA by industry - difference between deflated value of output and IC (deflated by respective price indexes) Best approach: combining the two using ‘supply and use table’ (SUT). This way, discrepancy between the two methods can be eliminated.

10 Price and Volume Indices – Points to Note Volume measures are obtained by valuing each individual quantity at its own prices in an earlier period – base year. Change of volume measures constitutes a Laspeyres volume index Quality change regarded as change in "volume" not a change in price Thus, at the aggregated level, the term volume is preferred to the term quantity.

11 Need for disagregated level Accounting The implicit price index (in GDP estimates) = (value at current prices / value at constant prices) is a Paasche Index. But, Laspeyres price index X Laspeyres volume index ≠ value index. Thus, it is essential to prepare national accounts at constant price at the most disaggregated level.

12 Level of Compilation (1) Practical solution: Conduct the deflation/extrapolation at the most detailed level possible (Elementary Level of Aggregation) Express all price and volume indices with the same reference period (base year), Ignore the index number errors introduced Conduct the aggregation from this detailed level and up to the main national accounts aggregates.

13 Level of Compilation (2) Errors are minimized when the level of aggregation is such that the differences are small between: –the available price and required Paasche price indices, and –the available volume and required Laspeyres volume indices. Generally, the errors introduced are small when –either the price movements for all individual items constituting the product group are approximately the same, or –when the corresponding volume movements are approximately the same. But, these conditions are difficult to attain in a hyper- inflationary situation – as in Iraq now.

14 Three Basic Methods of Constant Price Estimation (1) Revaluation: physical quantities of output and intermediate consumption are both revalued at the corresponding prices of the base year. It requires –quantity and price data at the product level –homogeneity of physical quantities for each product –complete coverage of the quantities transacted Thus, adopted for agricultural and livestock products. Deflation: each period's current price value divided by an appropriate price index. Volume extrapolation: Base year's value multiplied by an appropriate quantity/volume index/indicator.

15 Three Basic Methods of Constant Price Estimation (2) The price relatives vary less than quantity relatives and thus more accurately measured - survey estimates of prices more efficient. Thus, “deflation” is expected to produce more accurate results than extrapolation with quantity indicators. But, this too does not hold good under hyperinflationary situations.

16 Price and Volume Indices – Relevant Issues Problem of Quality Change Treatment of Unique Products Unit Values and Price Indices

17 Problem of Quality Change Methods of adjustments in price index: Overlapping; Unadjusted price comparison; Automatic linking (assumes no price change); Matched models only; Production costs, Judgmental approach, and Hedonic adjustment Methods of adjustments in volume indicators: A part of the quality change (in fact, compositional changes) can be captured by differentiating as many qualities as possible and treating them as different products.

18 Treatment of Unique Products Unique product represents a discontinuity in the calculation of price indices. [Example: ships, aircraft, construction, and management consultancy.] Common Treatment: Combine price movements of sub-activities to an overall price movement for the unique product. Two ways : –Model Pricing –Specification pricing Both model pricing and specification pricing are resource-intensive methods. Alternatives discussed later.

19 Unit Values and Price Indices (1) PI: based on observed price-relatives on a fixed sample of products –Reliability rests on how representative the sample UVI: Change over time of ‘Unit value' (= total value / total quantity). Problems: –heterogeneity may cause a large variability UVI. –changes in composition (though should be reflected as change in volume) can affect UVI. –adjustment for quality changes not possible.

20 Unit Values and Price Indices (2) UVI suitable when composition is stable. When volume change is positive, UVI overstates the price change. At a detailed level UVIs and PIs converge. Examples of use of UVI (other than for exports & imports): –Index of average wages, instead of wage rate index –Index of 'hourly fees‘ = total turnover / # hours worked: Often used for some business services (lawyers or accountants), instead of Index based on a sample of ‘charge-out rates’ (hourly fees charged).

21 Three Principles for European Commission’s Decision Principle 1: In the measurement of prices and volumes a detailed level of aggregation of products (referred to as the elementary level of aggregation) shall be used. Principle 2: Volume measures available at the elementary level of aggregation shall be aggregated using the Laspeyres formula. Price measures available at the elementary level of aggregation shall be aggregated using the Paasche formula. Principle 3: Volume measures derived at the elementary level of aggregation shall be aggregated using weights derived from the previous year.

22 Why Rebasing? For Constant price estimates, weights used for combining different volume components depend on their relative prices in the base year. Thus, estimates of ‘real growth rate’ depends on the choice of base year. Constant-price estimates tend to become less relevant progressively, with changing pattern of relative prices. Thus, rebasing is necessary to adopt more current weights.

23 Chain-linked Volume Index (1) To provide a comparable time series, the old series is linked to the ‘new’ (sub-script ‘n’) series, resulting in a set of chain-linked time series. Chain-linked Laspeyres index (L ot ), [sub-scripts ‘o’ and ‘n’ for ‘old’ & ‘new’, respectively] for the t th period L ot = L on * L nt An annual chain-linked Laspeyres index series from period ‘o’ to period ‘t’ can be constructed as L o,t = L o,1 * L 1,2 *L 2,3 *....* L t-1,t

24 Chain-linked Volume Index (2) In an annual chain-linked series, the weight- base period and the price-base is changed every year; the period ‘o’ is often referred to as ‘reference period’. The chain-linked values at the ‘reference period’ prices are not additive. But, each link, i.e. the estimates the prices of a previous period are additive. Thus, national accounts accounting identities for integrated price and volume measurements still hold good in an annual chain-linked series.

25 How often should base year be changed? Most countries do it once in 10 years, some every year – annual chain-linking. Users sometimes chain-link the published unlinked quarterly price & volume indices – resulting in quarterly base change The 1993 SNA recommends an annual change of base year and publication of annual chain-linked volume indices. Under hyper inflationary situation with large changes in relative prices, frequent base year change desirable. At least, annual chain-linking, if not quarterly, required under hyper inflation.

26 Accounting under Hyper Inflation – the Central Problem Activities and flows towards the end of a year are valued at much higher prices than those at the beginning. Accounts at current prices simply add together the values of these flows even though they are not commensurate. Quantities recorded towards the end of the year are implicitly treated as of markedly superior qualities of the same products earlier in the year.

27 Constant Price Level (CPL) Accounts Remedy: Adjusting values of flows at different points of time – to a same general price level. Method: Dividing the values in successive sub- periods (months/ quarters) by a suitable general price index for some convenient reference point - middle of the year. Resulting accounts: Constant Price Level (CPL) accounts. [INFLATION ACCOUNTING - A Manual on National Accounting under conditions of High Inflation - Peter Hill, OECD (2003)]

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