Economic and political commentators paid plenty of attention to the credit rating downgrades announced by Fitch and Standard and Poor’s late in September. The implications for interest rates and New Zealand’s ability to borrow were among their obvious concerns and politicians of all stripes argued about who should cop the blame. Prime Minister John Key put his credibility rating to the test, too, with claims about what Standard and Poor’s thought of Labour’s economic policies.
Some technical stuff announced by Statistics New Zealand on 10 October – not accorded the same big headlines – has implications for interest rates, also. It concerned the composition of the consumers price index; shifts in the index will tell Reserve Bank governor Alan Bollard every few weeks if he should lift the official cash rate, lower it, or leave it where it is.
The announcement – by Statistics NZ prices manager Chris Pike – was that the department had completed review of the goods and services in the CPI basket. The review also updated the relative importance of the contents of basket. It was scheduled to be implemented when the re-weighted CPI for the September quarter was announced on 25 October.
Reviews of the CPI are undertaken every three years to ensure the basket remains relevant and up-to-date and that its contents reflect changes in household spending patterns. The new basket includes tablet computers, external computer hard drives, e-books, and flatbread. Unflued gas heaters, dictionaries and envelopes were discarded.
Based on the Household Economic Survey (which covered about 3100 households to collect detailed information on spending habits) Statistics NZ estimates that $23.55 of every $100 spent by households on goods and services in the CPI basket is spent on housing and household utilities (up from $22.75 in 2008, reflecting increased spending on rent and higher electricity prices) while food accounts for $18.79 (up from $17.83, reflecting 14 percent rise in food prices over the past three years). Transport’s share eased from $16.18 to $15.12, helped by lower spending on cars.
Dr Bollard is charged with using the official cash rate and monetary policy to deal with inflationary pressures. His decisions are intended to keep the general level of CPI inflation within 1-3 percent target band.
But Antony P Mueller, professor of economics at the graduate business school of the University of Caxias-do-Sul in Brazil, reckons the monetary policy concept of inflation targeting suffers from fundamental problem: valid price index (he insists) does not exist. “There is no such thing as representative basket of goods and services,” he claims.
The idea of inflation targeting was problematic when it was first applied in the more simple economy of the 1920s; “nowadays it is outright obsolete to establish an index that would be representative of the highly complex and diverse economy as it exists today”.
His point is that each person has his or her specific basket of goods and services, and its composition will change for that individual over time. Your personal inflation rate will depend on slew of factors, such as whether you have children and how much you spend on health and insurance
In recognition of this reality, Britain’s Office of National Statistics few years ago introduced “calculate-your-own-inflation” tool. It shows that many people’s personal inflation rate – determined by how they spend their money – is higher than the national average.
Professor Mueller has gone further, however, to say aggregates and averages such as the gross domestic product, productivity growth, or the many other economic indicators consulted by central bankers, economic forecasters and the financial press hide more than they reveal “and are often utterly misleading for decision-making and economic analysis”.
Maybe. Dr Bollard is not likely to abandon them, however, if only because they are the best of bad kit of tools. What the statisticians have just put into the revised CPI basket, accordingly, will have raft of economic effects. M
Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.
