Monday, August 01, 2011

COLEBATCH: The CPI is not a credible basis for policy action

I've already pointed to ways in which both the headline and underlying CPI's are overstating inflation.

Colebatch points to another. The 15th series CPI is at the end of its run - right at the end of its run.

Towards the end it gets crappy. It overrates price movements in things we no longer buy and underrates price movements in the things we actually buy.

It is using weights set in 2005.

From this quarter the CPI will use weights derived from the 2009-10 Household Expenditure Survey.

It'll be fixed.

The Reserve Bank knows this.


"In this environment, you need a very, very good reason to raise interest rates and the CPI is not it.

It shows inflation is low in most of its 90 sectors of consumer spending. In the year to June, a third recorded falling prices, a third recorded rises within or below the target, and a third recorded price rises above 3 per cent.

It is a similar story even in the first half of 2011. The unweighted median price rise of those 90 items was well inside the Reserve's target zone. But the weighted median was outside it, partly because the index over time overstates our spending on items with rising prices, and understates spending on those with falling prices.

Take bananas and computers. When this series began in 2005, fruit and vegetables comprised 2.1 per cent of our spending, and computers 1.5 per cent. But fruit and vegetable prices have soared since cyclone Yasi, while computers now pack far more power than in 2005.

But the bureau assumes we still buy just as many bananas, even at $12 a kilo, and buy 2005-strength PCs very cheap. So the CPI is estimated on the basis that fruit and vegetables now comprise 3 per cent of our spending, and computers just 0.5 per cent. And that is wrong.

Likewise the CPI seriously overstates our spending on tobacco, and understates spending on mobile phones. And when the weights are wrong, that means the data itself is also wrong.

The Reserve faces a tough call. But it must not jump at shadows. This is a weak economy; it has time to wait. The next CPI figures will be based on a 2009-10 survey of household spending. That will restore the CPI as a credible basis for policy action."

Related Posts

. Take a deep breath. Inflation is not as bad as it looks

. The CPI is broken. Give us money and we'll fix it

. Wednesday column: So you think you trust the Consumer Price Index?