What is the difference between the CPI and SLCIs?
The CPI and SLCIs are closely related. All these indexes measure changes in prices paid by the household sector (consumers) for a basket of goods and services provided by other sectors of the economy (e.g. Government, businesses). The weights in the ‘basket’ represent amounts of expenditure by households on goods and services bought from other sectors. Goods traded between households (like buying and selling existing houses) are excluded as both sides of the transaction occur within the household sector. This means there is zero net expenditure by the sector on these types of goods and they are therefore excluded from the basket.
The basket classifies the various items of household expenditure into 11 broad groups. The basket of goods and services is updated regularly. The relative expenditure (also referred to as ‘weights’) on the goods and services in the basket is updated annually.
The key differences between the CPI and the SLCIs are:
- Their primary use. The CPI is primarily used as a measure of inflation while the SLCIs more closely reflect people’s cost of living.
- The SLCIs measure the change in prices of goods and services and how these changes affect the cost of living for selected household types (employees, age pensioners, other government transfer recipients, self-funded retirees and pensioner and beneficiary households) while the CPI is presented as a measure for all households.
- The way they measure changes in prices related to housing.
How does the CPI measure housing?
Housing is the highest weighted group in the CPI, accounting for around one quarter of the basket. It includes new dwellings purchased by owner occupiers (houses, townhouses and apartments), rents and major renovations. Including new dwelling prices captures the cost of adding to the housing stock.
The two largest components of housing are new dwelling purchases by owner occupiers (8.5 per cent of all household spending) and rents (7 per cent of all household spending).
- For detached houses, the ABS collects information from builders in each capital city, which includes prices of project houses and details of any promotions or bonus offers. A ‘matched model’¹ approach is used, where prices are collected each quarter for the most common type of project houses being built in each city. These houses are ‘matched’ over time so that price changes are calculated on movements between ‘like’ houses based on attributes such as number of bedrooms, size of the house etc. Where necessary an adjustment may be made to ensure that the quality of the houses priced over time remains the same.
- The rents series includes rents paid by new and existing tenants on privately owned and government-owned properties. For privately owned dwellings, the ABS collects data from real estate agents for a sample of rental properties in each capital city.²
The remaining components of Housing include maintenance and repair of dwellings, property rates and charges, and utilities. Utilities comprises electricity, gas and other household fuels and water and sewerage.
How do the SLCIs measure housing?
The SLCIs are the best source of information about how changes in owner-occupied property prices and interest rates are impacting households’ cost of living. The SLCIs show changes in out-of-pocket expenses for different groups of households (eg. pensioners and employees) including those related to mortgage interest charges. Changes in mortgage interest charges are impacted directly by changes in interest rates, and indirectly through changes in property prices which can increase or decrease the size of new loans on which mortgage interest is charged.
The SLCIs measure changes to mortgage interest charges (due to both changes in interest rates and debt levels) that apply to the purchase of newly and previously purchased properties. Therefore, mortgage interest charges in the SLCIs reflect both changes in property prices and changes in the interest rates that apply to finance the cost of purchasing the dwelling and land.
Like the CPI, the SLCIs only include purchases made by owner occupiers as properties purchased by investors are forms of investment rather than consumption.
Why are owner occupied housing costs measured differently in the CPI and SLCIs?
The CPI and SLCIs are similar in most ways but differ in the treatment of owner-occupied housing costs. This is because each index is designed for a different purpose.
The CPI is a macroeconomic measure of household sector (consumer) price change - inflation.
An important use of the CPI is to inform monetary policy. The Reserve Bank of Australia (RBA) is responsible for monetary policy and has noted ‘an inflation target is the centrepiece of the monetary policy framework'.³ An inflation target involves setting a target cash rate, which influences other interest rates.
Countries that adopt an inflation target as part of their monetary policy framework, typically exclude the measure of mortgage interest charges when measuring the CPI. This is because changes in the cash rate would directly affect inflation if the cost of mortgages was included in the CPI.
Why does the CPI exclude the purchase of existing dwellings and cost of land?
Housing in the CPI excludes existing dwellings, the cost of land, and mortgage interest charges.
The CPI excludes the purchase of existing dwellings as these are traded between households. Since both sides of the transaction occur within the household sector, there is zero net expenditure by the sector as a whole.
The CPI measures price change for a selected basket of goods and services that households consume. Land prices are excluded from the CPI as it is classified as investment not consumption.
How are mortgage interest charges measured in the SLCIs?
Mortgage interest charges are measured using the following two components:
- Interest rates – This reflects the cost of financing the purchase of the owner- occupied property (which includes both the dwelling and land)
- Mortgage debt – The amount of mortgage interest paid depends on the size of loans (mortgage debt) taken out to finance mortgages. Mortgage debt levels change as the price to purchase owner-occupied property changes.
Therefore, mortgage interest charges in the SLCIs reflect both changes in dwelling price and changes in the interest rates that apply to finance the cost of purchasing the dwelling.
When calculating the current level of housing debt, the ABS uses a ‘mortgage debt profile’⁴. This includes existing loans as well as new loans and represents the aggregate of all mortgage debt held by households in relation to owner-occupied housing. The ABS also updates the mortgage debt profile to reflect changes in residential property prices over time.
Interest rates are calculated from interest paid to the banks as a proportion of debt outstanding, which includes fixed, variable and revolving credit loans for owner occupiers. These interest rates are then applied to the mortgage debt profile.
Price changes in mortgage interest charges are published separately for different household types in in the SLCIs.
How are grants and purchasing incentives captured in housing in the CPI?
Government grants and subsidies are included in the CPI where they impact the level of consumption of a good or service.
The price change for new dwellings is measured net of subsidies and grants that reduce the price paid by the consumer. This includes first home buyers’ schemes, which are measured as price reductions to the new dwellings series.
Builders may also offer purchase incentives on their house designs. If the same house design is available with higher quality fittings for the same price, this is treated as a price reduction to the new dwellings series. The ABS adjusts for these promotional or bonus offers, reflecting the take-up rates and estimated additional value to the consumer.
The impact of the HomeBuilder program on household expenditure is also measured in the new dwellings series. The HomeBuilder grant is paid to eligible consumers once they provide evidence that work has commenced, and payments have been made. The reduction in cost is shown in the CPI in the quarter in which the grant payments are made to purchasers.
Where else does the ABS measure the price of residential housing?
As well as CPI and SLCIs, the ABS measures changes in housing costs in the Residential Property Price Indexes (RPPI). The RPPI measures changes in residential property prices and the total value of Australia’s dwelling stock. The RPPIs are based on sales of both new and existing residential properties including land.