The cpi, inflation and the cost of living

Inflation is a hot topic in financial markets, even though it remains subdued by historical standards. Having said that, many people would argue their cost of living has risen much more than official figures suggest.

So how do we measure inflation?

In New Zealand, the key inflation measure is the consumer price index (CPI), which is calculated by Stats NZ. It measures the changes in prices that households are facing, by tracking the prices of individual items that make up a representative basket of goods and services.

Each quarter, Stats NZ collects about 100,000 prices, by visiting supermarkets and many other shops. It sends surveys out to a range of businesses, and visits websites to collect evidence of current prices.

Stats NZ reviews this basket every three years to ensure it remains relevant, given our spending patterns change over time.

Delving into the adjustments in the CPI basket over the decades is fascinating, nostalgic, and it makes for a great summary of the trends we’ve seen come and go.

Saveloys and audio cassettes were added in the 1970s, waterbeds and wine coolers in the 1980s, and soy milk and hummus entered the fray in the 2000s.

Vaping devices and exercise equipment were added in 2020, while over the last 30 years we’ve seen compact discs, cordless telephones and dictionaries removed.

Today, housing and household utilities are the most dominant at almost 30 per cent, followed by food at 18.7 per cent and transport at 11.9 per cent. As one would expect, these necessities of life represent almost 60 per cent of the CPI basket.

Current CPI basket weights

Does the CPI paint a true picture of what the average household is experiencing?

Using a representative basket is a reasonable way of gauging our overall change in living costs, although like all one size fits all solutions it won’t accurately reflect everyone’s situation.

While the price of new cars, entertainment, air travel and computing equipment have fallen, many of life necessities continue to steadily creep higher.

Inescapable expenses like dwelling insurance and local authority rates are up dramatically over the last decade, while electricity and gas costs have also risen.

Segments of society which find themselves spending a greater proportion of life necessities would strongly disagree with the assertion that the cost of living in recent years has been as low as the official figures suggest.

Stats NZ releases a Household Living-costs Price Index that attempts to estimate the change in the cost of living for different groups within our society.

Some hit harder than others

The highest income group has seen a below average increase in living costs, most likely because of this group’s ability to purchase many of the discretionary products which have become more affordable in recent years.

In contrast, the lowest income group has faced a higher increase in the cost of living, as have beneficiaries, superannuitants and Māori.

Increase in living costs (2011 – 2021)

It is also worth noting that even though annual CPI inflation has very low at just 1.4 per cent over the past decade, asset price inflation has been very strong.

Fuelled by exceptionally low interest rates, capital has flooded into housing and sharemarkets, as well as collectibles like art, antiques, or classic cars. This has been a significant wealth generator for those lucky enough to own such assets.

Are we headed for higher inflation?

In the immediate future, we think inflation is headed higher. Many businesses are facing cost pressures due to supply bottlenecks, labour shortages, rising commodity prices and a sharp rebound in economic activity as the world reopens.

However, some of these issues will dissipate over the next 12 months, and some of these increases could prove transitory.

We should also remember that some of the structural trends that have led to low inflation over the past 30 years remain very relevant.

Technological change is arguably the most powerful of these, and there is unlikely to be any let-up in advancements that continue to make our lives easier and cheaper.

Globalisation has been another important factor, with lower wage economies replacing manufacturing in parts of the developed world, while an aging population will also impact consumption trends.

We should also note that consumer and government debt levels are now much higher than in the past. Over time, this might lead to a waning propensity to borrow and spend at the same rate as recent history.