Stuff Digital Edition

The shrinking dollar

Explainer: A new generation is confronted by the spectre of inflation, back to erode buying power and the value of savings. Tom Pullar-Strecker reports.

The Treasury expects inflation figures released by Stats NZ on Thursday will show the consumer price index rising at an annual rate of 5.5 per cent, which would put inflation at its highest level in 31 years.

But what exactly is the consumer price index (CPI) and can we trust it?

The short answers are that it is the single most commonly quoted measure of inflation globally and, while it is only an estimate, it should be trustworthy – so long as people are aware of what it is and what it isn’t.

But it will slightly overstate the impact of many price rises, while also not taking into account some of the cost pressures that home-owners, in particular, may be feeling in their back pockets.

What is it?

The CPI is a measure of inflation that Stats NZ calculates four times a year and releases about a month after the end of each quarter.

It measures the changes in the prices of a basket of 649 commonly-bought goods and services, which are accorded different weights in the index according to how much people usually spend on them.

The basket is not completely comprehensive; about 80 per cent of consumer spending that could be tracked by the CPI is on items that are included in the basket, with the other items deemed too trivial or difficult to track.

The omissions should have little if any effect on the CPI, though, unless the items that are not included are for some strange reason rising or falling in price by a very different amount than everything else.

What’s in the basket of goods and services?

It includes common food items, rent, cigarettes, whiteware, petrol, the top 10 selling fiction books, and services such as haircuts, restaurant meals and local government rates.

More about housing costs later. Stats NZ decides what should be included in the basket in large part through a separate Household Economic Survey that monitors the spending habits of 3900 households.

Those households are required to keep a tally of their spending over a two-week period and are also surveyed on their big purchases over the year.

To illustrate the cut-off point for inclusion in the basket, boys’ sweatshirts and underpants, cordless phones, travel guides and reams of computer paper are among 13 items that were dropped from the basket in 2020.

Newly included in 2020 were vaping products, surgical fees and exercise equipment.

If you are randomly selected by Stats NZ to take part in that survey, bad luck, by the way. You are legally obliged to, and you are not paid for your trouble.

Stats NZ does not take the information from the Household Economic Survey totally on trust though.

For example, it bumps up the weighting of alcohol and tobacco in the CPI to take into account evidence that people don’t tend to reveal all their purchases of those products.

My spending habits have changed since Covid, how has that affected the basket?

In general, Stats NZ follows international advice not to chop and change what’s in the basket to reflect what may be temporary changes in spending habits.

The CPI is designed to be an objective measure of prices, and each change makes the CPI a less reliable indicator of price movements over time.

But there’s a trade-off here that requires a bit of judgment.

Stats NZ senior manager Aaron Beck says it recalibrated the weighting of airfares in the CPI to reflect the fact people are no longer travelling overseas much, for example.

‘‘It would have been very peculiar for us to keep pricing flights that nobody could take.’’

How does Stats NZ check prices?

In part by the ‘old school’ way of visiting shops and other businesses.

But increasingly it is sourcing information directly from companies, including supermarkets, by having them supply it with the average prices of the CPI basket products and services they sold.

For goods and services sold online, it can simply be a matter of checking a website.

Stats NZ carries out about 100,000 price checks each quarter to compile the CPI.

The prices it is interested in are the actual prices consumers are paying, after any discounts as the result of a sale or promotion.

This year I’ve had to spend more at the supermarket because cheaper products have often sold out. Is that reflected in the CPI?

In general, it wouldn’t be.

Tinned tomatoes are a product in the CPI basket, for example, and Stats NZ tracks the price of a range of branded and unbranded cans to see how their prices change.

If the price of the individual brands remains the same, but shoppers end up spending more on tinned tomatoes because there are no ‘home brand’ cans left, and they need to buy more expensive brands, that won’t be reflected as a price increase in the CPI.

However, Stats NZ says it does include the cheapest available bread and milk as a component in its calculation for the price of bread and milk, so if the normally-cheapest brand is sold out when Stats NZ does a price check on those

Stats NZ assumes consumer spending is consistent, but in real life some people would buy lemons if the price of limes rocketed. items, that should be reflected in its calculation of inflation.

You also said the CPI can slightly over-estimate general inflation?

Yes, that is mainly because Stats NZ currently assumes consumers will still buy the same goods and services in its CPI basket, regardless of whether prices go up or down.

That won’t be the case, as at least some consumers will change their spending in response to price changes, dampening the impact.

If the price of limes suddenly triples because of a bad harvest, for example, some people will buy lemons instead, but that ‘‘substitution bias’’ is not reflected in the CPI.

Stats NZ estimated last year that substitution bias would have led it to overestimate the annual inflation rate by about 0.2 percentage points, but it can only estimate the impact after the fact.

Housing?

Stats NZ includes changes in rents, the cost of maintaining houses, and changes in the price of new homes – but not the land they are built on – when it calculates the CPI.

It doesn’t include changes in the price of existing homes or what people shell out in mortgage payments.

The treatment of housing in the CPI has long been controversial, but more so recently given that house prices jumped 28 per cent in 2021.

According to

Stats NZ,

If you are randomly selected by Stats NZ to take part in the Household Economic Survey, you are legally obliged to, and you are not paid for your trouble.

rents currently comprise about 9.9 per cent of the CPI, while the price of new housing makes up 9.1 per cent, so as it stands, housing costs comprise 19 per cent of the index.

But with mortgage payments included, housing would comprise a higher share of households’ total spending.

Is the current approach sensible?

Arguably there is no ‘right or wrong’ and instead it really depends on what you are using an inflation figure for.

For example, if you were using an inflation figure as a basis on which to index-link superannuation payments (which New Zealand doesn’t), you might want a measure that excluded changes in the price of owner-occupied housing.

That would be on the basis that relatively few retired home-owners would be shelling out for mortgages on their main home, so there would be little need for super payments to rise to reflect higher mortgage costs.

Stats NZ also publishes a Household Living Costs Price Index that attempts to measure the cost pressures experienced by 13 socio-economic groups, such as households on different income levels, including owner-occupier housing costs.

Stats NZ says that treatment ‘‘aligns better with the inflation experiences of owner-occupier households’’.

But including mortgage repayments in inflation figures does have one paradoxical implication.

Namely?

Central banks use inflation data to help decide whether they should be heating or cooling the economy by raising or lowering interest rates.

Normally, their response to higher inflation would be to raise the official cash rate to bring inflation down.

But if the price of mortgage repayments is included in the calculation of inflation, then raising the OCR could be expected to have the immediate, direct effect of increasing inflation by that measure.

The Reserve Bank’s data needs are viewed as quite important. In fact, Stats NZ makes clear that the primary purpose of the CPI is to ‘‘inform monetary policysetting’’.

But it’s all manipulated to make inflation look lower than it is, right?

Well, no.

‘‘There is a playbook developed internationally that we follow to the letter,’’ Beck says.

‘‘If prices go up, we capture it, and if they go down, we capture it too. They’re not manipulated by circumstances and they are not manipulated at all by government pressure.’’

I still reckon prices are rising faster than they say.

It is perfectly possible that for you, they may be. Inflation can affect households to quite different degrees that won’t be reflected in the CPI figure, potentially depending, for example, on commuting and rent costs.

As mentioned, the frequent nonavailability of particular brands of goods in supermarkets due to supply constraints can have an impact that will not always be taken into account in the CPI, and rising house prices are their own big topic.

But there may also be psychological factors at play that make us notice price rises more than price drops.

‘‘We are so evolved, aren’t we, to notice things that make our living environment less comfortable to be in?’’ Beck says.

‘‘And less cognisant of things that are making things a bit more easy.’’

Business Business

en-nz

2022-01-23T08:00:00.0000000Z

2022-01-23T08:00:00.0000000Z

https://stuff.pressreader.com/article/282879439131786

Stuff Limited