DIFFERENCES BETWEEN “LIVING COST” AND “INFLATION” INDEXES
1 The differences between indexes designed to measure price inflation and indexes designed to measure changes in living costs lie only in the item coverage.
2 A living cost index is intended to be used to assess changes over time in the purchasing power of the after-tax incomes of households. It is therefore concerned with measuring the impact of changes in prices on the out-of-pocket expenses incurred by households to gain access to consumer goods and services. The item coverage of such an index is determined by reference to the actual money outlays of households on all but investment items. On the other hand, an inflation index is defined to cover all those goods and services actually acquired by households in monetary transactions.
3 Construction of the living cost indexes was essentially undertaken in three stages. Stage one was concerned with calculating weights representative of the expenditure patterns of the defined household types. Stage two involved identifying appropriate measures of price change for each of the expenditure weights. The third and final stage was to use the weights to aggregate or average the price change measures.
4 Item weights for the population subgroups were derived mainly from the Household Expenditure Survey (HES). However, unlike the CPI where weights are calculated separately for each of the eight capital cities, population subgroup weights were calculated at the national level only. This was necessary because the subgroup sample sizes at the capital city level were simply too small, for at least some groups, to produce reliable estimates at the capital city level. For this reason it is not possible to produce living cost indexes at the individual city level.
5 The measures of price change, with the exception of those for interest charges, were sourced from the CPI. Price measures for interest charges have been maintained separately by the ABS on a basis comparable with those employed in the CPI prior to September quarter 1998.
6 While most item price indexes were constructed by direct reference to the equivalent CPI expenditure class indexes, some were constructed by reference to lower level CPI price data. The exceptions relate to those items where it is known that different household types face different prices, such as subsidised public transport fares for senior citizens.
7 Over time the ABS will progressively refine the methodology used to construct these indexes to better reflect other differences in prices that may be faced by different household types. An example is making allowances for the possibility that different household types make purchases at different outlet types.
THE POPULATION SUBGROUPS
8 Principal source of income is considered to be the best means of defining household types in order to meet the requirements for living cost indexes. Four household types have been identified as being appropriate for the construction of these indexes, namely:
- Employee households (i.e. those households whose principal source of income is from wages and salaries);
- Age pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
- Other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension) and,
- Self-funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the Household Expenditure Survey (HES) defined reference person is ‘retired’ (not in the labour force and over 55 years of age).
These indexes were constructed using three sets of weights. The first set of weights, based on the 1993-94 Household Expenditure Survey (HES), was used to construct the indexes from June quarter 1998 to June quarter 2000. The second set of weights, based on the 1998-99 HES, was used to construct the indexes from June quarter 2000 to June quarter 2005. The third set of weights, based on the 2003-04 (HES), was used to construct the indexes from September quarter 2005 to June quarter 2006. All indexes are linked at June quarter 2005.
MAIN METHODOLOGY DIFFERENCES FROM THE CPI
There are a number of ways to construct a consumer price index with at least three widely accepted alternative approaches used by national statistical agencies:
- Acquisitions method: changes in the prices of goods and services acquired (actually received)
- Cost of Use method: changes in the prices of goods and services used (consumed)
- Outlays method: changes in the prices of goods or services for which payments were made to gain access to goods and services
From September quarter 1998, the CPI has been designed specifically to measure price inflation for the household sector as a whole. It is therefore constructed using the acquisitions method.
These living cost indexes represent the conceptually preferred measures for assessing the impact of changes in prices on the disposable incomes of households. They are particularly suited for assessing whether or not the disposable incomes of households have kept pace with price changes. These indexes are constructed using the outlays approach.
In practice, for most goods and services purchased by the reference population, outlays and acquisition occur within a relatively short space of time. There are three areas of expenditure in which these conceptual approaches provide significantly different results:
- purchase of dwellings
- purchase of durable items
- financial services and the use of credit
Under the acquisitions approach in the CPI, the net purchase of housing, the increase in volume of housing due to renovations and extensions and other costs (e.g. maintenance costs and council rates) are included for owner-occupied housing. Changes in rental are measured for that part of the reference population that resides in rented dwellings.
Under the outlays approach in these living cost indexes, the changes in the amount of interest paid on mortgages and other costs (e.g. maintenance costs and council rates) are included for owner-occupied housing. Changes in rental are measured for that part of the reference population that resides in rented dwellings.
Insurance (other than health insurance) is also treated differently in the living cost indexes. Under the acquisitions approach, the weight for insurance in the CPI relates to the net value of the service provided by the insurance company. In simple terms, the amount of premiums paid by households less the amounts reimbursed by way of claims. Under the outlays approach in these living cost indexes, the weight relates to the gross value of insurance premiums paid by households.
Financial services also treated differently in the living cost indexes. The living cost indexes include mortgage interest and consumer credit charges but exclude all other financial services.
Regional weights for the CPI are based on the HES distributions in the capital cities, however the weights in the analytical living cost indexes are based on the HES distributions for the State or Territory. This produces more reliable weights for some of the smaller expenditure categories in these living cost indexes.