So, the Bureau of Statistics has spoken. This week we learnt that
prices rose by a mere 0.2 per cent in the three months to December,
reducing the annual rate of inflation to just 1.7 per cent. But how does
the bureau come up with such figures? And who believes them?
Short answer: not everyone. The public knows so little about
how the consumer price index is calculated, and the bureau's figures
seem so much lower than the impressions of rising prices people gain
from their own experience, that many people suspect the figures are just
cooked up by bureaucrats in an office somewhere.
In reality, the structure of the CPI has been carefully
thought through and a lot of effort and shoe-leather goes into ensuring
the figures we are given each quarter are as reliable as possible. It's a
trickier business than you might imagine.
For a start, there are lots of different ways to measure
inflation. The bureau publishes maybe half a dozen different measures,
of which the CPI is just one. You can measure the change in prices paid
by businesses ("producer prices") or those paid by consumers, or a
combination of both.
Even so, the CPI is by far the most widely used measure. As explained by the bureau on its website,
it measures changes in the price of a fixed basket of goods and
services bought by consumers in the households of the nation's eight
capital cities.
Each quarter the bureau checks the prices of about 100,000
items. Prices are collected by visiting supermarkets, restaurants,
department stores, schools and websites. These physical visits, in all
states and territories, are supplemented by prices collected by
telephone or the internet.
The aim is to collect the prices people are actually paying,
so when items are on special or being discounted, the lower price is
counted.
The 100,000 separate prices are grouped into 87 broad
expenditure classes. These are then categorised into 33 sub-groups and
11 main groups: food and beverages; alcohol and tobacco; clothing and
footwear; housing (rents, new house prices, repairs and maintenance,
council rates, water, electricity and gas); furnishings, household
equipment and services; health (including private health insurance);
transport (motoring and fares); communication (telecommunication
equipment and services, postal); recreation and culture (including
audio-visual and computing equipment and services; newspapers and books;
holiday travel and accommodation; sports, toys, hobbies and pets);
education (public and private preschool, primary, secondary and
tertiary); and insurance and financial services.
About every six years the bureau does a large survey, asking
people to record exactly what they're buying and how much of their
income they're spending in each category. It then adjusts the items
included in the CPI basket of goods and services to ensure they are up
to date.
More significantly, it uses this "household expenditure
survey" to give each of the items in the basket the right "weight", or
relative importance. You can't just throw in one loaf of bread, one new
refrigerator and one new car. Bread is cheap but we buy several loaves a
week, while refrigerators and cars are expensive, but we buy a new one
only occasionally.
The bureau has been revising the content of the CPI basket
and the weights given to the various spending categories every few years
since 1948, as our habits and the economy have changed. Over such a
long period, the relative importance of spending categories has changed a
lot.
Then, and on average, food accounted for 31 per cent of
household budgets, whereas today it's less than 17 per cent. Similarly,
clothing and footwear has dropped from 22 per cent to 4 per cent. And
household supplies and equipment have gone from more than 13 per cent to
9 per cent. Alcohol and tobacco have gone from almost 11 per cent to 7
per cent.
But if all these things are taking a smaller proportion of
the household budget, it's only partly because they have become
relatively cheaper. It's mainly because we are spending on things now
that didn't exist 67 years ago, or choose now to devote a higher
proportion of our hugely higher real incomes to some things but not
others.
The classic example of the latter effect is housing: its
share of household budgets has almost doubled to more than 22 per cent.
And with most households now owning at least one car, spending on
transport has almost doubled to 12 per cent of budgets.
Then there are the spending categories that have pretty much
popped up out of nowhere: recreation and culture, 13 per cent; health,
more than 5 per cent; insurance and financial services, 4 per cent; and
education and communications, 3 per cent each.
One point to add: though the Reserve Bank's inflation target -
to hold the inflation rate between 2 and 3 per cent on average over the
cycle - refers to inflation as measured by the CPI, in practice it pays
most attention to the average of various measures of "underlying"
inflation, derived from the CPI.
This is because the "headline" CPI is quite volatile. It
tends to bounce around because of the ups and downs in such things as
petrol prices and the prices of fresh fruit and vegetables (caused by
the weather), but also because of the one-off effect of government
policy changes, such as the abolition of the carbon tax.
The Reserve Bank is interested in assessing the strength of
general inflationary pressure in the economy and doesn't want to be
distracted by temporary price changes that have extraneous causes. So it
uses various statistical techniques to remove this volatility.
Its measures of underlying inflation showed that prices rose
by 0.7 per cent in the December quarter and by about 2.3 per cent in
2014. Taken by itself, this gives the Reserve no reason to change the
official interest rate on Tuesday.
