Mark Lister: Consumer Price Index and the cost of living

Mark Lister asks: How do we measure inflation anyway? Photo / Getty Images

COMMENT:

The cost of living has been a hot topic this week, after Monday's much stronger than expected - yet unsurprising - inflation report.

But how do we measure inflation anyway, and does it paint a true picture of what the average household is experiencing?

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.

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

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 doesn't accurately reflect everyone's situation.

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

Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. Photo / Supplied

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

Segments of society, which spend a greater proportion of their income on these staples, would suggest that the cost of living has risen strongly for years, rather than just in 2021.

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.

The highest income group has seen a below-average increase in living costs, most likely because of its ability to buy 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.

It is also worth noting that even though annual CPI inflation has been very low at just 1.8 per cent over the past decade, asset price inflation has been very high.

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

In the immediate future, inflation pressures are likely to worsen. Businesses are facing ongoing cost pressures due to supply bottlenecks, labour shortages, rising commodity prices and a rebound in economic activity as the world reopens.

Longer-term, the picture is a little murkier. Some of the inflationary pressures are a hangover from the pandemic and should dissipate over the next 12 months.

At the same time, structural trends that have led to low inflation over the past 30 years remain relevant. Technological change has been 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 having replaced manufacturing in parts of the developed world. However, the tide has been turning on globalisation, and this could work in reverse in the years ahead.

Higher debt levels (for consumers and governments) could also affect future inflation. On the one hand, this could see a waning propensity to borrow and spend, although it also provides an incentive for policymakers to let inflation run hotter than usual (in the hope of inflating away that debt).

Despite this unclear longer-term picture, in the here and now inflation and interest rates look to be headed higher, which mean many borrowers are in for a bit of a shock.

Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.