Does the CPI method of calculation accurately reflecting the housing costs facing households? This has been subject of much discussion and RBA has released 98 pages of information under a FOI request – “Documents relating to the removal of mortgage interest rates from the CPI series in September 1998 and documents relating to the housing component of the CPI between September 2016 and September 2017″.
The FOI papers go through from the 1997/8 decision by the ABS to change the housing element of CPI from an “outlay” to “acquisition” approach. Market prices for goods and services are exclusively utilised… Non‐monetary transactions (i.e. imputed prices, such as imputed rent) and interest rate payments are excluded. This is the method the RBA supported.
There was much discussion in the documents as to whether house prices are connected with actual dwelling construction costs, rather than the market rate, which is more to do with sentiment, location etc. [Compare similar property in Sydney versus Tasmania, for example].
This from 2017:
Papers this morning continue to discuss the ‘massive flaw’ in the consumer price index (CPI). The Daily Telegraph headlines ‘flaw in RBA calculations hits home’, though the article later clarifies that it is referring to the Australian Bureau of Statistics’ ‘premier’ inflation gauge, which guides the Bank in its monetary policy deliberations. Articles say the main problem (revealed in a Commonwealth Bank analysis released yesterday) is the exclusion of a broad measure of property price growth in the CPI calculation. It is argued that including dwelling prices in the CPI would ‘assist’ the Bank in hitting its inflation target. This suggests that the current cash rate setting is too low, which in turn is fuelling the property boom and leading to record high household debt.
Recent media reports have discussed the treatment of housing in the CPI, arguing that due to the exclusion of dwelling prices (including land) the CPI understates cost of living pressures for those looking to purchase property.
The media reports refer to a Commonwealth Bank (CBA) article, which argues that the CPI is considered to be a defacto cost of living index. The author suggests that the cost of a dwelling, including land, is part of the inflation faced by households who aspire to own a home. By adding in a measure of dwelling prices (with a 10 per cent weighting), CBA suggest that CPI inflation would have been much higher over most of the past decade.
This would mean the policy interest rate setting was too low.
The CBA article uses the residential property price index to measure owner-occupied housing costs. This is not suitable for a cost of living measure. A dwelling is an asset that provides a stream of housing services.
The cost of living index should measure the cost of obtaining the housing services, which is the user cost, not the cost of obtaining the dwelling itself. The user cost will be affected by the price of the dwelling, but it will also reflect other considerations, such as the real interest rate. Of course, changes in the prices of existing dwellings are still relevant to debates about intergenerational equity. Changes in dwelling prices, like changes in the prices of financial assets, can affect the relative wealth of different demographic groups.
In response, the ABS said “The Australian CPI is primarily used as a macro‐economic indicator to monitor and evaluate levels of inflation in the Australian economy. The CPI is not designed as a cost of living index.” This is consistent with earlier statements by the ABS”.
Also worth noting in today’s ABS release, they stick to the acquisition approach.
Under the acquisitions approach used in the CPI, the net purchase of housing, the increase in volume of housing due to renovations and extensions, plus other costs (e.g. maintenance costs and council rates) are all included for owner–occupied households. Of note, land is excluded from the calculation of housing in the Australian CPI as it is considered an investment rather than consumption. This approach aligns with international statistical standards and the primary purpose of the CPI as a macro–economic indicator. Changes in rental are measured for that part of the population that resides in rented dwellings. The CPI excludes interest paid on mortgages.
