6401.0.60.002 - Information Paper: Increasing the Frequency of CPI Expenditure Class Weight Updates, July 2016  
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INTRODUCTION


CURRENT ABS PRACTICE

1.1 The Australian Consumer Price Index (CPI) measures the change over time in the prices paid by households for a basket of goods and services. The basket reflects the composition of household consumption preferences, is compiled according to international standards and is based on robust data collection and compilation methodologies. In compiling aggregate measures of price change, the role of expenditure weights is to reflect the economic importance of each item to the total expenditure of Australian households. Therefore, in practice, National Statistical Offices (NSOs) periodically update expenditure weights to accurately reflect changing purchasing patterns of households.

1.2 The structure of the Australian CPI can be viewed from a top down approach to show the various levels of aggregation used in compilation (Figure 1.1). At the top is the total expenditure or pool of items purchased by the reference population. This is known as the All groups CPI and is commonly referred to as the headline rate of inflation. Below this, the index branches into finer and finer commodity groupings until the lowest level, where there are samples of prices for the individual items (elementary aggregates). Indexes are published down to expenditure class (EC). This is the level of the index for which the structure and weights are fixed for the life of a CPI series.

Figure 1.1 Consumer Price Index Structure
Figure 1.1 represents the current Consumer Price Index (CPI) aggregation structure, from the elementary aggregates (the basic building blocks of the CPI) to the All groups (the highest level of the index structure).


1.3 The division of the groups and sub-groups is intended to reflect increasing levels of substitutability of the items consumed by households in response to changes in relative prices. For example, at the group level there are unlikely to be any substitution effects between Food and non-alcoholic beverages and Transport in response to changes in their relative prices. However, within the Oils and fats EC it would be expected that households are more likely to substitute between margarine and butter in response to changes in their relative prices (ABS 2011).

1.4 With respect to upper level weights, the Australian CPI has 87 ECs whose weights are primarily sourced from the Household Expenditure Survey (HES) and updated every six years. Expenditure data is initially collected using the Household Expenditure Classification (HEC) which is then mapped to the Consumer Price Index Commodity Classification (CPICC). The HES is supplemented with a range of other data sources to update EC weights. As of the 16th Series review, 70% of the weight is derived from HES. The remaining 30% of the weight is derived by combining HES data with data from other sources, as well as utilising a range of other ABS and non-ABS data sources (footnote 6)


1.5 For the Australian CPI, the 16th Series was implemented in September quarter 2011 and uses the HES collected for the financial year 2009-10. The HES is the preferred data source to derive expenditure weights, primarily due to the ability to control for spending patterns of the population group (i.e. metropolitan households). It is a sample of approximately 7,000 metropolitan households where data is collected using a diary of personal expenditures for residents aged 15 years and older over a rolling two-week period. An interview questionnaire also collects information about each household's characteristics, expenditures common to all members of the household and irregular or infrequent expenditures.

1.6 The HES records all data as reported by the households. For some product groups, adjustments are required to the information reported in the HES before it can be used in the CPI. For example, HES data for alcohol and tobacco expenditure is adjusted using National Accounts HFCE data to account for under-reporting. In other cases, the HES may be supplemented or replaced by other data which provide a more accurate estimate of expenditure(footnote 1).

1.7 Consumers' purchasing patterns react to price change over time, where goods and services with high inflation are typically substituted with low inflation alternatives. This shift to lower inflation goods and services is known as item substitution. Most NSOs, including the Australian Bureau of Statistics (ABS), use a fixed-base Laspeyres(footnote 2) -type formula, also known as Lowe(footnote 3) index formula to measure price change. The fixed-base index formula keeps quantities underlying the base period expenditures fixed over the life of the basket. These quantities are applied as weights to the prices in both the current period and the base period to produce the latest period's price index. Keeping the quantities fixed is done primarily for practical reasons, given the difficulty in measuring quantities accurately every period. One limitation(footnote 4) of this is that it does not take into account substitutions consumers make in response to relative price change, resulting in substitution bias. As a result, NSOs attempt to mitigate the effects of substitution bias by updating upper level weights periodically.

1.8 Infrequent weight updates have a statistical impact on the Australian CPI. The ABS has previously conducted research on this substitution bias, estimating an average upward bias of approximately +0.24% per year for the period June 2000 to June 2011 (ABS 2011). The measurement of the upward bias was not constant over time, with a larger bias estimated for periods further away from the weight updates. These results are similar to other countries investigations into substitution bias (SNZ 2014).

1.9 In response to this analysis during the 16th Series review, the ABS investigated the feasibility of conducting a four-yearly HES. A four-yearly HES was discussed for several reasons. The upward bias increases the further the index is from the weight reference period; and most significantly after four years. A four-yearly HES would enable integration with other ABS household surveys, and would deliver considerable benefits to a range of users including National Accounts, researchers and policy makers.

1.10 Without additional funding for the ABS, a more frequent HES is not feasible. The ABS has therefore investigated alternative data sources to increase the frequency of CPI weight updates.


HFCE DEFINED AND THE CURRENT ABS RESEARCH PROGRAM

1.11 As part of the "Enhancing Australia's CPI" work program, the ABS has reviewed data sources available for re-weighting the CPI more frequently. The availability of annual Household Final Consumption Expenditure (HFCE) data from the National Accounts provides the ABS with an opportunity to update CPI EC level weights more frequently. The International Labour Organization (ILO) endorses the use of HFCE data from the National Accounts when the time interval between household surveys is large, concluding that "household expenditure data in the national accounts may provide the best estimates of aggregate household expenditures" (ILO 2004, p.28). HFCE data is used by other NSO for CPI re-weighting purposes, including the Office of National Statistics (ONS) in the United Kingdom and Statistics Netherlands(footnote 5) .

1.12 HFCE measures expenditure by resident households on goods and services, whether the expenditure is made within the domestic territory or by Australian residents abroad, and expenditure by Non-Profit Institutions Serving Households (NPISH). Conceptually, the measurement of HFCE aligns closely with the HES. HFCE data captures household expenditure, including the Goods and Services Tax (GST). Both HFCE and HES data cover expenditure by Australian households only and exclude expenditure by non-residents in Australia.

1.13 HFCE data is available across a range of classifications (e.g. Input-Output, Supply-Use) that are differentiated by their level of aggregation. This paper focuses on annual HFCE data at the Supply-Use level. The compilation of Supply-Use tables are an important tool in balancing the production and expenditure estimates of Gross Domestic Product (GDP), utilising a large number of data sources including business activity surveys, household expenditure surveys, investment surveys, foreign trade statistics, government finance statistics and administrative data. GDP data is published by the ABS in the Australian System of National Accounts (cat. no. 5204.0).

1.14 The HES is used as a major benchmark in the compilation of the HFCE series. Benchmarking is a technique used by National Accounts, where less frequent (higher quality) data sources are used to validate more frequent estimates of HFCE. The other major benchmark used for HFCE is the Retail and Wholesale Industries (cat. no. 8622.0).

1.15 The use of HFCE data for CPI weights has many potential benefits for both internal and external users of inflation statistics, including more representative weights while at the same time aligning with international recommendations. The use of HFCE data will ensure the continued production of a robust CPI; and provide greater coherence between macro-economic statistics within the ABS.

1.16 There are, however, several challenges with using HFCE data for CPI weights. These challenges are grouped together as:
      i) Overarching challenges - encompassing classification, scope, coverage, and revision challenges; and
      ii) Specific EC challenges - encompassing a case-by-case assessment of using HFCE data for specific CPI ECs.

1 See chapter 6 of 6461.0 – Consumer Price Index: Concepts, Sources and Methods, 2011 for a comprehensive description of adjustments made to upper level weights. <back
2 A price index in which the basket is composed of the actual quantities of goods and services in the earlier of the two periods compared. <back
3 The Lowe index is similar to the Laspeyres index with expenditures revalued to the price reference period (see paragraph 3.7 below). <back
4 Another limitation of fixed quantities is that changes in income are not reflected in the CPI weights. <back
5 See Appendix for a list of Organisation for Economic Co–operation and Development (OECD) countries weighting procedures. <back
6. See Appendix 1 for a complete list of expenditure data sources used to derive the 16th Series CPI <back