What is inflation and what does it mean for 2022?

Summary

Learn how inflation is calculated and how this might impact you.

Content

As the global economy recovered from its COVID-related lockdowns last year, there was a spike in inflation, particularly in the US.

At the outset of 2022 the question remains whether that uptick in inflation will prove to be a temporary one or not. We all know that feeling when our dollars don’t seem to stretch as far as they used to. But do we understand how inflation is calculated?

To brush up on some inflation basics, read on. Headline inflation rate The most well-known measure of inflation is the Consumer Price Index (CPI). It measures the percentage change in the cost of a basket of goods and services consumed by Australian households.

The quarterly headline CPI figure is based on prices of about 100,000 items, which are grouped into 87 categories and 11 groups including housing, health, recreation and culture, insurance and financial services and communication. The price data is collected from a wide range of sources from retailers and online services to government authorities, utilities providers, and real estate agents.

The ‘basket’ of goods and services and their weights in the basket is based on what households in Australia spend their income on and how much they allocate to each item.

If households spend more of their income on one item that item is given a larger weight in the CPI. For example, housing has a 23 per cent weight while clothing and footwear is only 3 per cent. What impacts CPI?

The basket can change over time to reflect spending trends. For instance, smartphones were added as technology changed.

But it’s not a rapid change as data on household spending across all the items is only available about every five years. The data only reflects changes in Australia’s eight capital cities. If you live in a regional area the price changes may differ. Likewise, the way your household spends may be different to the way the basket is weighted. A household may not have a car or spend less on health, for example.

The figure that is published also doesn’t reflect quality changes in the goods and services only price changes. So if you get a better smartphone for your money as technology improves that doesn’t show up in inflation figures. Underlying inflation

Underlying inflation indicators exclude items that have particularly large price changes, often driven by temporary factors. For instance, a cyclone that wipes out a fruit harvest one year can lead to a significant hike in prices.

Or a change in tax regulation, such as the introduction of the GST, can cause the prices of many items to rise. In Australia the indicators of underlying inflation are known as the trimmed mean and the weighted median.

The items removed from these baskets can vary each quarter and the indicators reflect seasonally adjusted price changes. For instance, high school fees typically rise in the March quarter so an adjustment is made to spread it out over the year. There is also a measure of CPI excluding volatile items, which leaves out fruit, vegetables, and fuel.

If you have any questions about inflation or the impact on your cashflow, please contact your financial adviser.