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APPENDIX 1: REPORT BY THE CONSUMER PRICE INDEX REVIEW ADVISORY GROUP ON ITS DELIBERATIONS ON THE 13TH SERIES REVIEW OF THE CONSUMER PRICE INDEX

INTRODUCTION

1 The ABS Information Paper: Issues to be Considered During the 13th Series Australian Consumer Price Index Review (Cat. no. 6451.0), hereafter referred to as the scoping paper, identified major issues for consideration in the 13th series review of the Consumer Price Index (CPI). It was provided to all subscribers to the CPI and placed on the ABS Internet site. Advertisements in major newspapers invited submissions to the review and two public seminars were held in each capital city. The ABS received 47 submissions from the public.

2 An Advisory Group, comprising representatives of major users (see Annex 1 for the composition of the Group), was formed to assist the ABS in its deliberations. The Group met on three occasions (16 May, 30 June and 7 October 1997). In addition to the meetings of the Group, the ABS held bilateral meetings with each member of the Advisory Group.

3 This report draws together the views of the Advisory Group on the issues raised in the scoping paper.


PRINCIPAL PURPOSE OF THE CPI

Scoping Paper

4 The scoping paper identified the principal purpose for which the CPI is required as being critical to any decisions about the method of compilation and the items included in the index. Uses of the CPI were classified under three general headings: as input to the income adjustment process; for the indexation of contracts; and as a measure of inflation for macro-economic policy management. It was noted that the first category had declined in significance in terms of wage and salary setting and there was an increasing requirement for a measure of inflation.

5 Three conceptual bases for a consumer price index were listed in the scoping paper. The outlays (or payments) approach defines the item coverage (basket) in terms of the actual amounts paid by households to gain access to consumer goods and services. This approach is most appropriate to the principal purpose of income adjustment for which the CPI was originally constructed. Other conceptual approaches are acquisitions, under which the basket is defined to include all those goods and services actually acquired by households in the base period, and cost of use approach under which the basket includes all those goods and services actually consumed (or used up) in the base period. Under the three conceptual approaches the main differences arise in respect of the treatment of durable goods, particularly housing, goods and services provided at non-market prices, and items of expenditure which cannot be directly resolved into a quantity and price component.

Summary of Advisory Group discussion

6 Given the critical nature of principal purpose to the conceptual basis of the CPI, the Advisory Group spent most of its time on this matter. The Group comprises representatives of users which have quite different interests in the CPI and it is clear that no consensus on principal purpose can be reached. It is felt that in these circumstances it is appropriate to summarise the view of each member, noting that full articulation of the arguments is contained in members' submissions.

Department of Social Security (DSS)

7 DSS makes payments of $42 billion per year in benefits to five million people and most of these payments are indexed to the CPI. Legislation is before Parliament that does not allow the single pension to fall below 25% of Male Total Average Weekly Earnings (MTAWE) and this safety net provision flows on to all pensions and family payments (about 70% of DSS beneficiaries). The CPI continues to be used to adjust pensions every six months. The MTAWE provision only comes into play in the event that the CPI adjusted pension falls below 25% of MTAWE. The remaining 30% of beneficiaries continue to have payments indexed by the CPI alone.

8 DSS regards the purpose of indexation as maintaining the purchasing power of payments and wants this to remain as the principal purpose of the CPI. DSS sees difficulties in moving away from the current practice. It would be impractical to have different indexes for various welfare groups. There are about 200 references to the CPI in DSS legislation. In addition, clients would view a move away from current indexation arrangements with suspicion. In particular, DSS believes that it would be a bad time to change the conceptual basis of the CPI if we are near the bottom of the interest rate cycle.

Commonwealth Treasury

9 The Treasury submission shows that the three conceptual bases of the CPI produce similar results in the longer term. Treasury argues that developments since the last review suggest the CPI should move to be a measure of inflation.

10 The previous CPI review recognised that income adjustment was still the major role for the CPI, although the wages system was going through a transition at the time. Wage negotiations are now more forward looking and have a longer term focus so that inflationary expectations are more important: hence the need for the CPI to measure inflation. In regard to social security payments, Treasury notes that the inclusion of mortgage interest payments means the CPI is not representative of the expenditure of welfare recipients and that MTAWE would be the dominant determinant of future pension adjustments. The increased policy focus on maintaining a low inflation environment requires a suitable, accurate and high profile measure of inflation. The inclusion of interest rates in particular makes the CPI inadequate, hence the use of the Treasury underlying inflation measure.

11 Treasury advises that the Treasurer would need to reach an opinion as to whether any change in the CPI methodology was materially detrimental to investors in indexed bonds (in accordance with the Treasury indexed bond prospectus). Treasury also advises that, while financial market participants accept the regular review of the CPI, there have been concerns expressed that a change to an acquisitions basis could produce, at particular points in time, CPI outcomes lower than would otherwise have been the case and thus reduce the returns from Treasury indexed bonds.

Australian Council of Trade Unions (ACTU)

12 ACTU submission notes that the CPI is of vital importance in wage adjustment. It is critical in arbitral proceedings before the Australian Industrial Relations Commission when award wage rates generally are to be varied in 'Safety Net' or national wage contexts. It is also important in enterprise bargaining, and is often explicitly mentioned in formal enterprise agreements (the Department of Workplace Relations and Small Business (DWRSB) notes that about 4.5% of enterprise agreements include reference to the CPI, while the ACTU has estimated the figure at around 9%). The ACTU argues that recent labour market changes are not reason enough to change the conceptual basis of the CPI. There are other measures of inflation available to policy makers and the cost of changing the CPI would not be worth it. While the ACTU acknowledges inflation measurement is important, income adjustment should be the main purpose of the CPI.

Department of Workplace Relations and Small Business

13 DWRSB considers that the CPI continues to play an important role in the wage adjustment process, even though the system is not as mechanistic as in the past. This, coupled with its concern that community acceptance must not be jeopardised, leads DWRSB to the view that the current outlays approach to constructing the CPI should be maintained. DWRSB is concerned that if mortgage interest charges are excluded, home buyers will not be adequately represented in the index. If it were decided to go with an acquisitions approach and reduce the weight for housing, DWRSB is concerned about public perceptions and in any event would still want an outlays index for wage and salary earners. DWRSB is not convinced that putting house prices into an acquisitions measure would accurately reflect living costs.

Australian Council of Social Service (ACOSS)

14 ACOSS considers that the CPI should reflect changes in household living costs in a timely manner and should be valid and credible. ACOSS leans towards an outlays approach as it is more credible in the eyes of the average household. ACOSS is not sure if the acquisition approach would achieve the Reserve Bank of Australia (RBA) objective of reducing inflationary expectations in boom times if the measure did not correspond to the commonsense perceptions of households with mortgage interest costs. ACOSS accepts that there are problems in including housing interest rates because of their volatility but supports publication of the current index and one excluding mortgage interest charges.

15 ACOSS is reluctant to have separate indexes for pensioners or other income support recipients. Recipients are a diverse group. ACOSS would like to explore the suitability of a measure excluding housing interest rates for income support households, but if this is different to the CPI it would not be credible to use it to index income support payments. ACOSS believes that more research should be conducted in order to better understand changes in the cost of living among different recipient groups.

Reserve Bank of Australia

16 The RBA argues that the CPI should be a measure of inflation, and therefore supports an acquisitions approach. Interest rates are conceptually different from other prices because they represent the relative price of current versus future spending, rather than being a component of the current price level. Inclusion of the level of interest rates is therefore conceptually inappropriate in an index that is used as a general measure of inflation.

17 The decision as to whether home purchase should be included in an acquisitions index of consumer prices depends on whether home purchase is considered to be consumption or investment. If it is counted as investment, it would be excluded from the index. If it is consumption, then it should be measured by the cost of net additions to the housing stock, excluding the land component.

18 The RBA also noted that the inclusion of interest rates in the CPI was inappropriate for indexation purposes in the case of pensioners who were net recipients of interest income. Inclusion of interest rates in the CPI for indexation purposes would amplify rather than reduce swings in their real income.

Dr Caton

19 Dr Caton supports the RBA views. He notes, however, that if a change to the acquisition approach were to be introduced, the timing could be unfortunate if interest rates were viewed as being at or close to the lower end of the cycle, with possibly unfavourable implications for both income-support recipients and the indexed bond market.

20 Dr Caton commented that the indexed bond market initially was unconcerned about possible changes to the CPI, but the degree of concern grew over time as the Review received more media attention. This increased concern was also reflected in subsequent submissions to the ABS.

State Treasuries

21 The New South Wales and Queensland Treasuries and the Queensland Government Statistician expressed the view that the CPI should measure inflation. The Queensland Treasury felt that the current headline CPI met the objective of measuring inflation, and that a second measure similar to the Commonwealth Treasury underlying inflation rate is needed as a tool for setting monetary policy. With Commonwealth payments to the States indexed to the headline rate and interest rates at a low, some States have expressed concern about the timing of any possible exclusion of mortgage interest charges. The inclusion of owner-occupier housing costs is relevant to these indexation arrangements because they were intended to ensure that each State and Territory has the capacity to provide a particular standard of service.

Australian Chamber of Commerce and Industry (ACCI)

22 ACCI argues that the primary purpose of the CPI is as a measure of inflation but also recognises that there are a wide variety of purposes for which the CPI is used. However, as the primary purpose of the CPI is to measure trends in inflation, ACCI supports the use of the acquisitions approach. But whichever approach is chosen, ACCI strongly believes that there should be only a single measure of inflation produced by the ABS.

23 ACCI is concerned that the introduction of the debt profile model in 1989 converted the CPI from a contemporaneous measure. ACCI prefers the simple revaluation approach which was the methodology originally used by the ABS. If the payments approach is retained, there is a need to look at the treatment of interest rates.

Professor Neutze

24 Professor Neutze notes that the CPI is used for two distinct purposes and there is a need for two separate indexes. It is more appropriate to keep the CPI as a cost of living index as it was originally structured this way and it is easier to change the understanding of financial markets than it is of households. Professor Neutze is surprised that those who want the CPI to measure inflation have not highlighted its narrow base, e.g. exclusion of capital and producer goods.

25 Professor Neutze notes that home purchase includes both an investment and a consumption element. The only way to adequately separate out the consumption element is to use the rental equivalence approach, although this presents practical problems in Australia given the relatively thin rental market. He does not see the RBA approach as credible as it would give too low a weight for housing in the CPI.

26 Professor Neutze accepts that inflationary expectations have become more important. At the same time a wider range of welfare payments is now indexed.

Australian Pensioners' and Superannuants' Federation (AP&SF)

27 AP&SF regards the main purpose of indexation as maintaining the purchasing power of pensions and other allowances and the adjustment of superannuation payments. This should remain the principal purpose of the CPI. AP&SF acknowledges that while inflation measurement is an important component, income adjustment should be the main purpose of the CPI.

28 AP&SF is aware of the significant debate occurring amongst older people about the relevance of the CPI to their circumstances, though for a number of reasons, is not willing to support the application of a special index for older people. A major factor is that there are significant variations within the retiree population and one 'pensioner' or 'retiree' index would not represent all older people's consumption patterns. Some older people will still do better or worse than the average from time to time. However, on balance, the current CPI-based approach to price movements is better than any alternative proposed so far. AP&SF, however, is concerned about a growing lack of confidence in the CPI amongst its constituency and supports actions by the ABS to restore this confidence.

Advisory Group view
29 The Advisory Group notes the many uses that are currently made of the CPI and they are expected to continue into the future. Irreconcilable differences of view exist among the Advisory Group about what should be the principal purpose of the headline CPI.


FREQUENCY

Scoping paper

30 The scoping paper noted several arguments for producing the CPI on a monthly basis. On international comparability grounds, all OECD countries except New Zealand and Australia compile a monthly CPI, while the International Monetary Fund's Special Data Dissemination Standard specifies that CPIs should be compiled monthly, while also allowing countries some flexibility in meeting the standards. A monthly CPI may also help in earlier detection of turning points.

31 However, the cost of producing a monthly CPI is considerable and unless compelling arguments emerged during the consultation phase, the ABS predisposition was that the CPI should continue to be compiled and published on a quarterly frequency.

Summary of Advisory Group discussion

32 Only the submissions of the RBA and one financial market participant support the move to a monthly CPI. The RBA recognises that a monthly CPI could be a 'noisy series', but argues that moving averages could be used to reduce this problem and still produce more timely information about changing trends in inflation. The RBA also proposes that, to reduce the cost of moving to a monthly CPI, the ABS could consider limiting coverage for the additional months to Sydney and Melbourne.

Advisory Group view

33 Overall, the majority of the Group is of the opinion that there is not sufficient justification to incur the costs associated with changing the frequency of compilation and publication of the CPI from quarterly to monthly.


POPULATION AND GEOGRAPHIC COVERAGE

Scoping paper

34 The present population coverage of the CPI is households with at least 75% of their income deriving from wages and salaries, but excluding the top 10% in terms of income, in the eight capital cities. The restricted population coverage reflects the historical use of the CPI in the wage and salary determination process and efforts to contain the cost of compilation.

35 The ABS proposed extending the population coverage to include all households given the wider use now made of the CPI. User views were specifically sought on the regional coverage required, the possibility of optimising the price collection for production of a national index and the need for indexes for subgroups of the population.


Summary of Advisory Group discussion

36 There is strong majority support for extending the population coverage to include all households. However the ACTU, in arguing that the principal purpose of the CPI should be a measure of living costs for wage and salary adjustment, supports the present population coverage.

37 There are strong differences of view within the Advisory Group on the issue of indexes for subgroups of the population. DSS, ACOSS and the AP&SF support the compilation, periodically, of subgroup indexes for analytical purposes. If the reference population is broadened beyond wage and salary earner households then the ACTU would support the compilation of a wage and salary earner index. On the other hand, the ACCI is strongly opposed, for reasons set out in its submission, to compilation of indexes for subgroups of the population.

38 There is no support among Advisory Group members for indexes at regional levels other than the capital cities, essentially on the grounds that the benefits of so doing are not seen as being commensurate with the costs.

39 Currently the CPI is constructed to produce indexes of a uniform standard for each capital city. The RBA argues that for its purposes there are only 'minimal advantages in having eight regional CPIs which usually move closely with the national CPI' and would support changes which would optimise the accuracy of the national index. State Treasuries are strongly opposed to any loss of detail in the capital city indexes.

Advisory Group view

40 Overall, the Group is of the view that:

• the target population for the CPI be expanded to all households;

• that the regional coverage remain with the eight capital cities;

• noting the strongly held contrary views of the ACCI, the ABS produce, periodically, experimental indexes for selected population subgroups possibly on an annual basis only; and

• the ABS investigate the advantages and disadvantages of optimising the index at the national level, noting the State Treasury views that the existing detail of the capital city indexes be maintained, and discuss further with key stakeholders when more information is available.
  
  

• decisions on the issue of a ninth group must be taken in the context of the conceptual basis of the 13th Series CPI, as should the appropriate treatment of mortgage interest costs; and

• household computers and software, tertiary education fees, financial charges and domestic and homecare services be included in the CPI, but that gambling should continue to be excluded for reasons set out in the scoping paper.

• the index of Selected State and local government charges be discontinued and replaced by an index of utility prices to be determined in consultation with State Treasuries;

• the approach to estimating prices of imported and domestically produced items be modified along the lines proposed by the RBA; and

• compilation of spatial indexes be accorded a relatively lower priority by ABS.