By MILLIE MUROI, Economics Writer
If you’ve ever looked at the latest inflation figures and thought to yourself it doesn’t really reflect the ballooning or shrinking prices you’ve been paying, you’re probably right.
Like most measures of our economy’s health, the consumer price index (CPI) – our main inflation gauge – is only a rough estimate of what’s happening to prices. It tracks changes in the costs of a vast range of things but also skips over some key items we spend on.
This week, we learned prices at the end of last year were climbing at the slowest annual rate since March 2021 at 2.4 per cent (a much more reassuring figure than the 7.8 per cent we were seeing two years ago). But if you feel like the prices you’re paying are moving to a different tune, they probably are.
The index, measured by the Australian Bureau of Statistics, basically tracks the change in the price of a typical “basket” of goods and services that we, as households, consume. Think: a big shopping trolley that carries a lot more than what you’d find in a supermarket. Sure, it includes eggs and fruit, but it also includes things like school fees, specialist visits and subscriptions to your favourite streaming platform.
Of course, you probably don’t spend on the exact same things, or buy the exact same amount, as people on the other side of the country – or even your neighbours – which is why the inflation measure isn’t a perfect fit for specific households.
The CPI is based on the average spending habits of everyone (well, at least those living in the capital cities). Then, based on this data, the bureau gives different “weightings” – a measure of an item’s relative importance in the total basket – to different items and categories. Things we spend a lot of our money on – like housing costs and food – get a bigger weighting in the index, meaning any changes in prices in those categories will shift the dial more when it comes to the final inflation figure.
Since the things we tend to spend on change over time, the bureau frequently updates these weightings.
The first ever “basket” in 1948, for example, put the proportion of our spending on food and non-alcoholic beverages at nearly one third, with dairy products alone taking up nearly a quarter of our food budget. Women’s clothing, meanwhile, accounted for about 10 per cent of our total spending. Combined with spending on men’s attire at nearly 5 per cent, our total spending on clothing back then took a bigger bite out of our budget than the 12 per cent we used to spend on housing!
Today, food and non-alcoholic drinks account for 17 per cent of the typical household’s spending, and both dairy products and women’s clothing just 1 per cent each – the latter being largely thanks to the rise of mass-produced and cheap imported garments. It’s perhaps little surprise that the biggest share of our spending is now on housing at more than 20 per cent, while transport, including our spending on cars, burns about 11 per cent (transport spending was measured through fares – such as the price of train tickets – which took up about 6 per cent of the typical household budget in 1948 before cars became widespread).
So, how does the bureau know what we’re spending on?
One way is through the household expenditure survey, which is conducted roughly every five years and gives the bureau an indication of how much we’re spending on different goods and services. It’s the reason why, for many years, the CPI weightings – only changed about every five years. Now, as collecting information has become easier and more digital, the weightings are updated every year and rely on various sources including retail trade and transaction data.
The bureau gets its pricing data by monitoring the prices of thousands of products. It looks for this information through everything from websites, to supermarket and department store data, as well as pricing data it receives from government authorities, energy providers and real estate agents.
Combining the pricing and weighting data gives us the consumer price index which is released in its complete form every three months. Since September 2022, the bureau has also published a monthly CPI reading, although the goods and services measured each month tend to alternate, giving us an incomplete picture of what’s going on.
As we’ve talked about, the CPI isn’t an accurate measure of our cost of living, although we all assume it is.
A better measure is the bureau’s “selected living-cost indexes” which break down changes in the cost of living for different types of households. Working households, for example, saw their annual living costs rise by 4.7 per cent last September quarter, while self-funded retirees only experienced a 2.8 per cent increase.
That’s mostly because different household types tend to splash cash on different things. Self-funded retirees and age pensioners might, for instance, spend slightly more on health, meaning any price changes there may bump their cost of living more than it would for working households.
But by far the biggest reason for the difference between working households and older cohorts is that working households are more likely to have a mortgage they are paying off. This means changes in interest rates – which are included in the selected living cost indexes but not the CPI – have a bigger impact on their overall cost of living.
It’s also one of the biggest shortcomings of the CPI. In the early 1990s, the Reserve Bank started using interest rates to target inflation: a practice that’s now become very familiar to us all. But later that decade, the bank asked the bureau to remove interest rates from the consumer price index. Why? Because the bank didn’t want the instrument it was using to control the rise in prices — interest rates — to be included among the price rises being measured. Your instrument should be separate from your target.
Instead, since 1998, the CPI has measured housing prices through changes in components such as rents, the cost of building new homes, and the cost of maintenance and repairs. But that means for the roughly one third of Australian households with a mortgage, the CPI is not a very good measure of the price pressures they are facing.
While the CPI is a rough estimate of the cost of living pressures we’re facing, if you feel like the pinch you’re feeling is harder or softer than the latest figures suggest, you’re probably right.
