Author Topic: CPI versus Cost of Living in Australia  (Read 4463 times)

Ozstache

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CPI versus Cost of Living in Australia
« on: July 22, 2014, 04:49:12 AM »
I've long been a believer that CPI in Australia, as measured by the ABS, has lagged actual cost of living increases by a percentage point or two. My belief was founded in the long-standing fight that recipients of the military pension I receive about it 'only' being indexed to CPI and should be indexed to wage growth instead.

While victory was achieved in changing this after the last federal election, with the change of the aged pension back to CPI indexation (from wage growth) and pretty much every other government pension being indexed to CPI, I believe the writing is on the wall for my pension to go back to being indexed the way it was.

I was all ready to get indignant about this, then I thought I'd go out and see what facts there were about CPI versus actual cost of living increases and came across the following paper from the RBA produced in Mar 2014: http://www.rba.gov.au/publications/bulletin/2014/mar/pdf/bu-0314-4.pdf

In short, the paper says that CPI over the last 10 years has actually tracked cost of living pretty well across various demographic groups and, if anything, overstates it slightly due to the effects of substitution bias and incomplete quality adjustments. As a result, wage growth has actually outstripped cost of living inflation by around 25% in real terms, strongly indicating that lifestyle inflation is really what's at play. Of course, many of us, myself included up until now, don't see it that way because of a few key psychological biases we all tend to have (eg. tendency to only notice price increases, particularly large periodic ones, of items we purchase frequently rather than decreases), but the facts are the facts!

Anyway, I think it is a well written paper based on seemingly reputable sources and facts and has certainly made me think that a life of CPI indexation for those fortunate enough to have a government pension will be no big issue to any of us lifestyle inflation resistant Aussie mustachians around here. Even for those without a pension, basing your SWR on CPI rather than wage growth is likely to give you a percent or so more headroom in your calculations, so a win there too.

What do other Aussies think of it? Beyond the psychological biases covered, does anyone have any solid evidence to the contrary of what is presented in this paper?

deborah

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Re: CPI versus Cost of Living in Australia
« Reply #1 on: July 22, 2014, 05:35:01 AM »
I agree with the paper. Clothes have certainly reduced in price, as have cars and electrical equipment. For instance, I bought a Mazda 121 new 15 years ago and paid a bit over $20,000 for it. The same price will buy me a much better new car today (and the Mazda 2 - with more bangs and whistles, better fuel consumption and safety is about 75% of what I paid for the Mazda 121). In that time, salaries have gone up substantially, as has inflation, so the original $20,000 would be worth a lot more now. Similarly, whenever a piece of electrical equipment has bust recently (blender, microwave) the replacement has been better and MUCH cheaper.

There was something I heard on RN a few years ago about the CPI basket changing (as mentioned in the article, the basket changes every 6 years to better reflect the goods and services being consumed). They were talking about the way the CPI had changed over the 6 years that the last basket was in place, and how some categories "now" were worth a substantially lower percentage of the basket than when that basket was first decided upon. Each time they change the basket, the ABS surveys what people are actually spending their money on, and chooses a basket that reflects their actual consumption.This ensures that the index is valid, and hasn't drifted too much away from actual consumption.

matchewed

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Re: CPI versus Cost of Living in Australia
« Reply #2 on: July 22, 2014, 05:40:39 AM »
May not be an Aussie myself but the US has a similar debate going on constantly. Many people have a big disbelief of our own CPI measurements the government puts out (there is even a website based on trying to debunk it; I won't lend any credence by even naming it... not worth it) and while our wage growth has been quite stagnant in odds with your situation, our cost of living hasn't really gotten more expensive, but what we determine as necessary has. Our lifestyle inflation and consumerism attitudes have eaten a bigger hole in our cash flow than the price of meat and gasoline.

Seems like a similar cultural trap has hit our southern hemispheric cousins. :)

Also obligatory link to a certain misplaced mod's guest post which illustrates this concept. http://www.mrmoneymustache.com/2012/07/08/early-retirement-cant-work-or-id-have-heard-of-it-before/

agent_clone

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Re: CPI versus Cost of Living in Australia
« Reply #3 on: July 22, 2014, 03:22:02 PM »
Yes and no.  If we take the basics in what people need to purchase on a regular basis as being food and accommodation.  Lets ignore the current cost of purchasing a home in Australia which as we know has done strange things in Australia and use the cost of rental accommodation.  Rent overall has tracked wage growth pretty well at having been ~20% of income for the last 50 years.  I'm not sure what food does here either but we'll say it probably tracks CPI.
If you are at the lower end of the income scale (e.g. on Newstart or a Pension) then you would be spending a greater proportion of your income on the basics of food and accommodation.  So if rent is tracking wages then increasingly there will be a lesser proportion of income for other things.
Then there is also the public housing issue...  I do believe NSW has a 10 year wait on public housing, I think in the ACT it is 2 years, however I could be wrong about this and I have no idea on the other states and territories but in general there is a chronic under supply.  This then means that eventually it gets to a point where housing costs too much as wages have increased more than CPI.
Otherwise yes there is a lot of lifestyle inflation and the bigger ticket items (such as electronics, cars, etc.) have decreased significantly over the last 10 years.  Personally I wonder what's going to happen when the $AU to $US goes down significantly.

kyleaaa

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Re: CPI versus Cost of Living in Australia
« Reply #4 on: July 22, 2014, 03:50:21 PM »
Most people have a hard time reconciling hedonic adjustments with what they observe about the cost of living even though the adjustments are mathematically correct.

Ozstache

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Re: CPI versus Cost of Living in Australia
« Reply #5 on: July 22, 2014, 05:20:43 PM »
I agree with the paper. Clothes have certainly reduced in price, as have cars and electrical equipment. For instance, I bought a Mazda 121 new 15 years ago and paid a bit over $20,000 for it. The same price will buy me a much better new car today (and the Mazda 2 - with more bangs and whistles, better fuel consumption and safety is about 75% of what I paid for the Mazda 121). In that time, salaries have gone up substantially, as has inflation, so the original $20,000 would be worth a lot more now. Similarly, whenever a piece of electrical equipment has bust recently (blender, microwave) the replacement has been better and MUCH cheaper.

There was something I heard on RN a few years ago about the CPI basket changing (as mentioned in the article, the basket changes every 6 years to better reflect the goods and services being consumed). They were talking about the way the CPI had changed over the 6 years that the last basket was in place, and how some categories "now" were worth a substantially lower percentage of the basket than when that basket was first decided upon. Each time they change the basket, the ABS surveys what people are actually spending their money on, and chooses a basket that reflects their actual consumption.This ensures that the index is valid, and hasn't drifted too much away from actual consumption.

Cars are definitely more feature packed, reliable and cheaper than they were many years ago. People look down their nose at my four year old Ford Fiesta, but it hasn't missed a beat since I owned it two years ago, sips on the fuel and has great features as standard. Even though newer cars offer more bells and whistles, are much cheaper now and I can afford it, I am unable to justify giving up the awesomeness I already have.

The revisions to the CPI basket make sense, even though it is likely many of us here don't buy the average Joe's basket of goods anyway. In researching this matter, I came across the Living Cost Indices on the ABS website, which include a self-funded retiree index which seems more in line with those of us in, or contemplating, ER. Interestingly, in the Mar 2014 quarter figures shown here http://www.abs.gov.au/ausstats/abs@.nsf/mf/6467.0 it has increased exactly the same as CPI over the last 12 months.

Ozstache

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Re: CPI versus Cost of Living in Australia
« Reply #6 on: July 22, 2014, 05:23:38 PM »
May not be an Aussie myself but the US has a similar debate going on constantly. Many people have a big disbelief of our own CPI measurements the government puts out (there is even a website based on trying to debunk it; I won't lend any credence by even naming it... not worth it) and while our wage growth has been quite stagnant in odds with your situation, our cost of living hasn't really gotten more expensive, but what we determine as necessary has. Our lifestyle inflation and consumerism attitudes have eaten a bigger hole in our cash flow than the price of meat and gasoline.

Seems like a similar cultural trap has hit our southern hemispheric cousins. :)

Also obligatory link to a certain misplaced mod's guest post which illustrates this concept. http://www.mrmoneymustache.com/2012/07/08/early-retirement-cant-work-or-id-have-heard-of-it-before/

Thanks for the international perspective matchewed. It seems us southerners are not alone in this matter!

And thanks for providing the link to arebelspy's guest post. I thought I had read every MMM article but it seems I missed that one. It convey's exactly what I am talking about.

Ozstache

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Re: CPI versus Cost of Living in Australia
« Reply #7 on: July 22, 2014, 05:37:21 PM »
Yes and no.  If we take the basics in what people need to purchase on a regular basis as being food and accommodation.  Lets ignore the current cost of purchasing a home in Australia which as we know has done strange things in Australia and use the cost of rental accommodation.  Rent overall has tracked wage growth pretty well at having been ~20% of income for the last 50 years.  I'm not sure what food does here either but we'll say it probably tracks CPI.
If you are at the lower end of the income scale (e.g. on Newstart or a Pension) then you would be spending a greater proportion of your income on the basics of food and accommodation.  So if rent is tracking wages then increasingly there will be a lesser proportion of income for other things.
Then there is also the public housing issue...  I do believe NSW has a 10 year wait on public housing, I think in the ACT it is 2 years, however I could be wrong about this and I have no idea on the other states and territories but in general there is a chronic under supply.  This then means that eventually it gets to a point where housing costs too much as wages have increased more than CPI.
Otherwise yes there is a lot of lifestyle inflation and the bigger ticket items (such as electronics, cars, etc.) have decreased significantly over the last 10 years.  Personally I wonder what's going to happen when the $AU to $US goes down significantly.

The subject paper correlates with what you are saying re disproportionate rent effects for lower income earners in table 2 on page 39, where it shows cumulative inflation for the lowest quintile income bracket to be 3-4% higher than the others over the last decade. The other thing that likely impacts low income households is if they buy more of the alcohol and tobacco 'essentials' category, which has also outpaced CPI over the last decade, in their basket of goods. The report doesn't directly mention this but I'd be surprised if that's not the case for those on the lower socio-economic scale. This is opposed to voluntary low income earners like ourselves in ER who'd find both the product and the health costs and effects associated with excesses in this category to be very unmustachian indeed!

Ozstache

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Re: CPI versus Cost of Living in Australia
« Reply #8 on: July 22, 2014, 05:42:15 PM »
Most people have a hard time reconciling hedonic adjustments with what they observe about the cost of living even though the adjustments are mathematically correct.

Indeed. My kids cannot fathom how we 'survived' without mobile phones back in the dark ages of our youth. My eldest son was horrified when we traveled around Australia and lost mobile phone coverage across most of the top between towns, but somehow we managed to make it through alive!

Annamal

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Re: CPI versus Cost of Living in Australia
« Reply #9 on: July 22, 2014, 06:00:50 PM »
New Zealand does a similar adjustment (Oh the outcry when soy milk replaced cheerio sausages)

Mark31

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Re: CPI versus Cost of Living in Australia
« Reply #10 on: July 22, 2014, 07:46:45 PM »
I'd been under the impression that pensions were now indexed to the "Pensioner and Beneficiary LCI (PBLCI) ". I believe under the Rudd government, money was provided to the ABS to add this to their CPI collection.

I haven't looked at all the different components of the CPI for a while, but it used to be that the things pensioners typically spent a greater proportion of their money on, like rates, electricity, food and health expenses and anything closely linked to Australian labour prices went up faster than the headline figure.

Ozstache

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Re: CPI versus Cost of Living in Australia
« Reply #11 on: July 22, 2014, 09:35:22 PM »
I'd been under the impression that pensions were now indexed to the "Pensioner and Beneficiary LCI (PBLCI) ". I believe under the Rudd government, money was provided to the ABS to add this to their CPI collection.

I haven't looked at all the different components of the CPI for a while, but it used to be that the things pensioners typically spent a greater proportion of their money on, like rates, electricity, food and health expenses and anything closely linked to Australian labour prices went up faster than the headline figure.

The aged pension is currently indexed to the greater of either CPI, MTAWE or PBLCI, but the government announced in the 2014 budget that this would be coming back to just CPI increases in Jul 2017. http://www.dss.gov.au/about-the-department/publications-articles/corporate-publications/budget-and-additional-estimates-statements/2014-15-budget/budget-fact-sheet-seniors-and-age-pension refers.

As you say, the PBLCI has exceeded CPI a few times in recent years. However, I would posit that ERed Aussies would be more aligned with the self-funded retiree LCI expense patterns than with PBLCI, and that has more closely aligned with CPI. See http://www.dss.gov.au/about-the-department/publications-articles/corporate-publications/budget-and-additional-estimates-statements/2014-15-budget/budget-fact-sheet-seniors-and-age-pension for more detail on the various LCIs and the excel file at http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/6472.02011?OpenDocument for a breakdown of the weights given to each LCI category.