Annual inflation in New Zealand as measured by the consumers' price index (CPI) is minus 0.4%. That is, an average basket of items of household expenditure cost 0.4% less in May 1999 than it did in May 1998.

There are a number of variations and subdivisions of the CPI. For example each city has its own CPI, as does each product group. The one kind of subdivision that is desperately needed but is not published is a CPI for different household types and for households of non-average incomes. Such households have significantly different consumption patterns from those specified in the standard basket.

There is, however, a subdivision that gives a hint of these differences; the superannuitants' price index (SPI). The SPI itself is broken down into a variant for renters and another variant for homeowners. In the 1990s, the general pattern is that retired renters have faced higher increases in their cost of living than have retired home owner-occupiers.

It is the task of the New Zealand Reserve Bank to ensure that annual inflation in New Zealand is kept between zero and three percent. While accurate as a measure of the cost of living of an average household, the CPI is not an ideal technical measure of monetary inflation. To the Reserve Bank, inflation means the "internal purchasing power of money", which is not the same thing as the cost of living. Thus the Reserve Bank has repudiated the CPI (what it calls "headline inflation"). It now uses a variant of the CPI called "CPIX", a variant of the CPI which excludes householders' debt-servicing costs.

The graph below shows annual inflation rates computed from the CPI, the CPIX, and the SPI for home owner-occupiers. It is interesting to note that the CPIX does in fact track the SPI [homeowners] quite closely.

The SPI [homeowners] is notable because it virtually omits two of the most important parts of the cost of living for low-middle income households: rent and debt servicing. (Superannuitant homeowners tend not to have mortgages.) Thus it can be said that success by the Reserve Bank, using a measure closely correlated to the SPI [homeowners], tells us comparatively little about the cost of living of New Zealanders, most of whom pay rent and owe money. Further, the falling mortgage servicing costs that cause the lower CPI values, are not reflected in the interest rates charged on credit cards or by loan sharks and pawnshops.

The CPI is misleading, both as a target for monetary policy (for which a variant of the PPI - producers price index - should be used), and as a measure of the cost of living.

If all workers were obliged by law to work with their left hands tied behind their backs, then the cost of producing all things would rise, although wages would not rise and the purchasing power of money would not change. Prices would rise because things were intrinsically more expensive and not because money had changed in value. (If prices did not rise, it would mean that a rise in the cost of things had been offset by a rise in the purchasing power of money. In that case, there would be a fall in wages.) Yet the Reserve Bank assumes that all rises in the general price level reflect a change in the value of money. The RB would respond to such a situation by raising interest rates, thereby adding further to the high cost of production.

(We might note that CPI and CPIX inflation are positively correlated, meaning that the CPIX measure that the RB uses shows higher inflation at times of high and rising interest rates. This reflects the impact of interest rates on production costs.)

For producers, high interest rates act like a deadweight production cost, much as having one-handed workers would be a deadweight cost. Conversely, a fall in interest rates is like releasing workers' tied hands.

Interest rates are an important component of the cost of living and an important component of business costs. High interest rates cannot be treated as always a cure and never a cause of inflation. But, having said that, interest rates, which cause the CPI to fluctuate above and below the CPIX and the SPI, have a very uneven impact on different household types.

The transaction costs of supporting an overmanaged government have a similar effect on the cost of living to high interest rates; they raise costs to all sectors of the economy. Indeed, the slight upturn in inflation this year (0.5% from February to May by the CPIX measure; 0.2% by the CPI) is due almost entirely to costs arising from government reforms such as the creation and propagation of "Crown Entities" like the Tourism Board.

Our measurement of household inflation (which means the cost of living and not the value of money) must continue to reflect the impact of interest rates and government reforms on production costs. Further, we need more variants of the CPI to reflect the different impacts of interest rates on households of different socio-economic circumstances. Ignoring the contribution of interest rates to the cost of living and to the costs of production is just wilful blindness.

© 1999   Keith Rankin

Rankin File | StatsWatch