The all-important Consumer Price Index includes everything but the household cost that is foremost in most people's minds: mortgage payments. So when setting salaries, there's another little-known index that we should be using instead.
ANALYSIS: When statisticians measure the rising cost of living, they include Big Macs. Fair enough. They're up 30c in the past year, contributing to the big 4.4 percent rise in the cost of restaurant and ready-to-eat meals that Stats NZ reported this week.
McDonald's NZ provided its pricing to Newsroom and to The Economist, which is compiling its biannual, global Big Mac Index. The burger with its two 45g beef patties, cheese, gherkins, lettuce and its famous "special sauce" now costs $6.90, averaged across the company's New Zealand restaurants.
Contributing to the chain's rising prices are increased prices for beef, coffee, dairy and packaging, plus costs to restaurants like utilities and other supplier costs, and increases in labour costs. The minimum wage rose to $20/hour in April this year, affecting many restaurant chains.
“McDonald’s restaurants review pricing periodically through the year, taking into account changing costs to the business," said spokesperson Simon Kenny.
“This can include things like increases in food commodity prices, and direct costs to the restaurants. While the majority of our food is purchased in meal bundles, at an a la carte level the average price of a Big Mac increased 30 cents in the last 12 months."
That price rise will be reflected in next month's Big Mac index, published by The Economist as a novel way of measuring whether the market exchange rates for different countries’ currencies are overvalued or undervalued. The magazine argues that as a Big Mac is a completely standardised product across the world, it should have the same relative cost in every country. Differences in the cost of a Big Mac expressed as US dollars therefore reflect differences in the purchasing power of each currency.
It's an example of how different inflation indices serve different purposes – and it raises an important question for New Zealand.
In our Consumer Price Index, why do we measure restaurant meals (up 3.8 percent in the past year according to this week's Food Price Index), yoghurt (up 6.8 percent), vegetables (up 4.2 percent) and "special sauces" and other condiments (down 2.9 percent), but we don't include the payments New Zealand's home-owners make on their massive mortgages?
The Consumer Price Index is the standard measure of inflation, and is expected to rise beyond 2 percent in the 12 months to June 2021. But that's not a patch on house prices. This week's REINZ figures show the median price of a house went up $200,000 last year – why is this not reflected in the Consumer Price Index?
There's a good and simple answer to that.
“You don't want to include anything that could influence monetary policy – it would be somewhat circular if you were to include interest payments in there." – Katrina Dewbery, Statistics NZ
For many years, public and private sector decision-makers have used the CPI to help them set salaries and benefit rates and much more. But as Statistics NZ consumer prices manager Katrina Dewbery explains, it was never intended to be used that way. The CPI is used by the Reserve Bank to inform its decisions on the Official Cash Rate. That's why interest payments are excluded, says Dewbery. Otherwise, it would create a loop in which the Reserve Bank increased interest rates in response to a rising CPI, which was increasing because of rising interest rates....
“It comes down to what the main purpose of the CPI is, which is monetary policy," she says. "You don't want to include anything that could influence monetary policy – it would be somewhat circular if you were to include interest payments in there."
It also doesn't include one-off person-to-person payments like the purchase of a house, which is net neutral to the economy. One person is up, the other is down.
The CPI does include rents, rates, insurances, and the costs of actually constructing a new house.
So the CPI is fit for the purpose it is intended for – guiding monetary policy – but it's no use at all for the purposes some businesses and government agencies put it to.
The good news is that there's an alternative. It's a little-known Statistics NZ measure of inflation called the Household Living Costs Price Index, and it is that index that employers and unions would be better to refer to when they argue for pay rises.
Statistics NZ publishes the Household Living Costs Price Index quarterly, a couple of weeks after the CPI. As the above chart shows, the HLPI (the blue line) is presently trailing slightly lower than the CPI. That is because, unlike the CPI, the HLPI includes interest payments, which are paused at an all-time low. When interest rates start rising, as forecast, then that blue line will quickly climb above the black line.
“The HLPI is a cost of living approach," Dewbery explains. "It doesn't include house prices per se, but it includes the amount that people pay to be able to live in their houses – so that includes interest payments. And rising house prices are contributing to an increase in interest payments."
Neither index includes the full price of purchasing a house. "People often get confused about not including that," she says. "But because you're not paying that full cost up-front, and are only making payment towards your interest, it's those payments that we include in the HLPI.
"So it's not going to show the same massive increase that house prices show, because it does have the interest rate component keeping it down as well."
"If everyone is using the CPI calculation, and interest rates go up, then we're not going to see an accurate picture of how people are affected." – Lesley Harris, First Home Buyers Club
Why does this distinction between CPI and HLPI matter? It's because the CPI is being abused. Te Kawa Mataaho, the Public Service Commission, compares civil servants wages rises to CPI increases. StudyLink adjusts student loan living costs in line with CPI. Student Allowance and supplementary assistance are indexed to CPI, less the cigarettes and tobacco subgroup. Inland Revenue is required to adjust household childcare standard rates in line with CPI. NZ Super is indexed to the greater of CPI or average wages.
The First Home Buyers Club warns that the exclusion of interest rates from CPI makes new home owners vulnerable, when interest rates go up but their CPI-indexed salaries and allowances don't.
"Particularly for people entering the housing market, it's a significant impact on their budget if interest rates go up significantly," says spokesperson Lesley Harris.
"We're lucky we're at an all-time low for interest rates now – we've never seen anything like 2 percent. But if everyone is using the CPI calculation, and interest rates go up, then we're not going to see an accurate picture of how people are affected."
This year, Social Development Minister Carmel Sepuloni announced benefits would no longer be indexed to CPI. Instead, they will rise in line with the average wage. That is a step in the right direction – except that wages are also often negotiated with reference to CPI. And wages lag behind a rising cost of living at the best of times.
The reliance on CPI in setting salaries and allowances is wrong. It's not what CPI was designed for, and when interest rates rise, it's not fair on those households that carry debt – whether it be bank mortgages or High St loan sharks.
As inflation begins to climb in coming months, how we set salaries and benefits will become ever more important.
