4.9 The ABS has classified issues raised by users as conceptual, methodological or data concerns.
4.10 There are three primary conceptual questions. First, should fees for financial services be included in a CPI? Secondly, should indirect fees be included in a CPI? And thirdly, should investment related expenditure be included?
4.11 Deposits and loans themselves are not consumption goods or services. However, financial institutions provide services such as financial intermediation (matching the requirements of borrowers with lenders), security and automatic teller machine access. These services are consumed by households and therefore fees associated with them should be included in a CPI.
4.12 A number of countries include direct fees in their CPIs, however Australia is the only country to include indirect fees. Householders may not observe these indirect fees as they are bundled with interest payments. These fees paid by households, however, represent genuine transactions. In addition, a CPI that incorporates only direct fees misrepresents price changes when financial institutions substitute between fees charged directly and indirectly. The ABS considers both direct and indirect fees as payment for services consumed by households and therefore concludes they should be included in the CPI.
4.13 As discussed in Chapter 2, there are several conceptual approaches for the construction of a CPI. The ABS has decided to retain the acquisitions approach for the measurement of household inflation. The CPI Manual (ILO, 2004) states that the scope of the acquisitions approach includes household expenditure on services including FISIM. This confirms that the ABS decision to include indirect fees for financial intermediation services in the CPI is supported in principle by the international statistical community.
4.14 A number of users questioned whether the inclusion of expenditure on investment related services (e.g. stock broking fees, real estate agent's fees and financial intermediation services on investments) was appropriate. The ABS has reviewed the System of National Accounts (SNA) and international price index literature on the concepts underpinning the treatment of investment services. These sources are consistent with the ABS interpretation regarding the treatment of investment activity in the CPI. The manuals state that the use of services related to investment is consumption activity and considered household expenditure, within the scope of a CPI.
4.15 In principle, service charges for superannuation products, which are not currently in the CPI, should also be included. Methodologies for their inclusion will therefore be assessed as part of the CPI forward work program.
4.16 The ABS has discussed the conclusions of the investigations with the AG and other users and there is strong support that conceptually both direct and indirect fees for all household deposit and loan facilities should be included in a CPI providing they can be accurately measured. However, questions have been raised regarding the behaviour of the Deposit and loan facilities index. These questions are related either to the indirect fee calculation methodology or the data used to calculate this aspect of the index. In the wake of the GFC there is a renewed debate internationally on FISIM measurement that will take some time to resolve.
4.17 A number of concerns with the methodology used to calculate the price change of indirect fees have been raised. The detailed methodology is not well understood and analysts find the index difficult to predict. The review has identified refinements capable of improving the existing methodology. However, in order to address issues with the treatment of fixed interest rate products or take into account changes in the cost of wholesale funding to banks, an enhanced methodology is required. Simplification of the existing methodology, to reduce complexity, results in a significant risk of introducing bias into the index. Further details of ABS analysis of the methodological concerns are contained in Appendix 6.
4.18 If price movements in the All groups CPI are compared with the All groups CPI excluding Deposit and loan facilities, major differences in the two series are evident. The Deposit and loan facilities index contributes approximately 4% to the All groups CPI. Therefore, the inclusion of the index has a significant impact on the CPI. The influence of Deposit and loan facilities on the All groups CPI does not represent a problem in itself. It emphasises, however, that particular care must be taken with price measurement as any inaccuracies arising from the calculation methodology will detract from the accuracy of the CPI.
4.19 To calculate the service price for Deposit and loan facilities, interest rate margins are multiplied by base period account balances indexed by a lagged four quarter moving average of the CPI. If no changes to interest rate margins are observed in consecutive quarters, this is the only movement in the index. This has been described as introducing inertia into the CPI. This view is correct, however the effect is judged to be extremely minor and has not been the focus of the review.
4.20 The Deposit and loan facilities index is quite volatile at times and has a positive correlation with the RBA cash rate target. The major driver of the index is changes to the spread between deposit and loan yields. If the spread between deposit and loan yields increases (decreases), the index will increase (decrease). Over the life of the index, the spread between deposit and loan yields has tended to vary in response to changes in interest rates. For example, yields on transaction deposit accounts tend to remain stable (around 0%) while yields on most loan products change in response to changes in the cash rate target. This leads to a correlation between the index and the cash rate target and should be reflected as price volatility. These effects have not been isolated to the GFC and were apparent in the experimental series of the Deposit and loan facilities index as early as 2001. The rapid interest rate rises and falls associated with the GFC have simply made these effects more prominent.
4.21 The use of the mid-point reference rate methodology raises concerns due to the asymmetry in the Australian domestic banking market. Only approximately half of financial institutions' loans are funded by domestic deposits. The majority of the remainder is derived from wholesale funding (Davies et al, 2009). Some recent yield increases on loan products were attributed to increases in these wholesale funding costs. The current methodology reflects this as a price increase (incorrectly) and highlights a potential weakness in the methodology.
4.22 The ABS has examined the treatment of fixed rate products. The Deposit and loan facilities index is highly sensitive to the treatment of term deposits and fixed rate loans. Indexes calculated for these products are highly volatile in times of interest rate changes. In Australia, variable rate products dominate movements in the reference rate. Effective yields on fixed rate products move much more slowly than the reference rate. As the interest rate margin is calculated from the difference between the product yield and the reference rate, this induces a high level of price volatility on fixed rate products. Some of the index volatility could be reduced by using alternative methodologies for fixed rate products.
4.23 A number of different reference rate scenarios have been considered to address concerns regarding: the use of a mid-point reference rate; the impact of changes in wholesale funding costs; and the treatment of fixed rate products. This is an area of ongoing international debate that will impact on a range of macroeconomic statistics produced by the ABS. International consensus on these issues is not expected in the short term.
4.24 To address sampling concerns the current procedure was evaluated. Currently a sample of a single (or occasionally two) representative product(s) is selected to represent each major product group. To overcome any issues with the sampling methodology the ABS will seek to obtain the detailed data necessary to commence constructing the index using a census of all consumer products instead of a sample. Further, to capture changes in the popularity of products over time, the ABS will conduct annual weight updates within the Deposit and loan facilities index. This will allow for inclusion of new product groups, such as online saving accounts, soon after their introduction. Both these adaptations could have a small but measurable impact on the resulting index.
4.25 To address the perceived lack of transparency, the ABS has evaluated the index against an index created using publicly available data. Overall trends (in the same direction) can be observed, however, quarterly movements cannot be accurately replicated. Some likely reasons for the differences in the two series are: publicly available data are much less detailed than the data obtained by the ABS; the ABS uses interest rates actually paid and received by households over the quarter whereas publicly available interest rates are advertised values and loan balances and are often reported at the end of the month (not an average across the month); and the ABS data covers securitised products which are generally excluded from publicly available data.
4.26 The ABS has investigated simplifying the methodology by combining data for products or product groups to make the index easier to understand and predict. However this has been found to result in significant inaccuracies in the index.
4.27 Users strongly suggested the weight of Deposit and loan facilities within the CPI was too high. The weights have been confirmed to be consistent with the methodology. Alternative data sources were used to perform an indicative recalculation of the average weekly expenditure on indirect fees and yielded similar results. It should be noted that the weight is determined by the methodology and variations of the methodology influence the weight.
4.28 An information paper on developments for FISIM measurement will be released prior to the 16th series CPI introduction in October 2011. The paper will cover, in greater detail, the rationale for the removal of the FISIM component from the CPI, the international debate over the measurement of FISIM, and the rationale for its reintroduction. Developments in measuring other financial services will be discussed in the paper.
4.29 The quality of the Deposit and loan facilities index has been found to be highly dependent on the accuracy and the level of detail of the input data. The ABS appreciates the considerable efforts made by providers to supply this data and the high level of cooperation received. The ABS invested significant resources to develop a robust methodology and produced an experimental series of the Deposit and loan facilities index from September quarter 1998 to December quarter 2003. During these relatively stable economic times prior to the introduction, the quality of data received by the ABS was appropriate and the index behaved according to expectations. The GFC, however, put strain on the ABS and other international statistical agencies' abilities to measure indirect fees. Interest rate volatility associated with the GFC increased the sensitivity of some index components to data. It became apparent that, if the index is to deliver accurate results in turbulent economic times, very detailed, high quality data are required. Currently, this data is not universally available from financial institutions. It is also a reality that from time to time, financial institutions will revise data supplied to authorities. This often occurs too late to incorporate the changes in the CPI.
4.30 The ABS will continue to work with data providers to obtain the high quality, detailed data necessary to measure indirect fees robustly. Negotiations are taking place to secure improved quality, product level data and consistency. The ABS will continue to work on data quality until it is sufficient for the index. This is unlikely to be realised in the short term.
4.31 Conceptually, both direct and indirect fees for Deposit and loan facilities should be included in the CPI. However, the GFC has demonstrated that the ABS methodology used to calculate indirect fees is not sufficiently robust, and the data are not currently available, to produce a high quality estimate of price change under all economic circumstances. The ABS will continue to work with the international statistical community and data providers to resolve outstanding issues and reach a solution consistent across the range of macroeconomic statistics, which includes calculation of indirect fees, that delivers improved accuracy under all economic conditions. From the introduction of the 16th series CPI in September 2011, indirect fees will be excluded from the headline CPI and an analytical series covering the All groups CPI inclusive of indirect fees will be published separately. Direct fees will continue to be included in the headline CPI, consistent with other international statistical agencies.