An update on the annual re-weighting of the Australian CPI and living cost indexes

By Arnold Akem, Economic Research Section

The Australian Bureau of Statistics (ABS) has maintained a program of periodic reviews of the Consumer Price Index (CPI) and Selected Living Cost Indexes (SLCIs) every six years, to ensure that they continue to meet community needs. The ABS conducted the most recent of these reviews in December quarter 2017 (ABS, 2017b).

In 2016, as part of the program to enhance the Australian CPI (ABS, 2015b), the ABS investigated the frequency of the CPI and SLCIs expenditure class (EC) weight updates. A feasibility study was conducted using Household Final Consumption Expenditure (HFCE) data from the National Accounts to annually update the CPI EC weights. The findings from this work showed that more frequent weight updates using HFCE data reduces substitution bias in the Australian CPI (ABS, 2016).

Following extensive consultation with key stakeholders, as well as peer review of methods and data sources by Prices and National Accounts experts, the ABS announced stakeholder support for the annual re-weight of the CPI and the intention to implement these new methods and data sources from the December quarter 2018.

The consultation also identified further topics for ABS investigation. These topics included: methods to more frequently re-weight the SLCIs; and providing methodological clarity for the calculation of CPI capital city weights in between the Household Expenditure Survey (HES) years (ABS, 2017a).

The ABS has now completed these investigations. The ABS is now in a position to update users of the CPI and SLCIs on the following:

• Annual re-weighting of the SLCIs using HFCE data.
• Methods to calculate the capital city EC weights for the inter-HES years.

The methods presented in this paper will be implemented in the December quarter 2018 for both the SLCIs and the CPI.

User and stakeholder comments and feedback relating to this paper are welcome. Please contact prices.statistics@abs.gov.au by Friday 28th September 2018 or write to:

Mr Leigh Merrington
Director
Economic Research Section
Australian Bureau of Statistics
PO Box 10
Belconnen ACT 2617

The ABS Privacy Policy outlines how the ABS will handle any personal information that you provide to us.

1.1 As part of the Enhancing Australia's CPI work program (ABS, 2015b), the ABS has reviewed data sources available to re-weight the CPI more frequently. Annually available Household Final Consumption Expenditure (HFCE) data from the National Accounts enables updating of the CPI and SLCIs expenditure class (EC) weights on an annual basis.

1.2 In 2016, the ABS proposed annually re-weighting the Australian CPI using HFCE data from the Australian National Accounts (ABS, 2016). The research presented gave empirical support for higher frequency re-weighting of the CPI to reduce substitution bias. The proposal to annually re-weight the CPI using HFCE data ensures greater coherence across macroeconomic statistics and aligns the ABS with international standards.

1.3 Following the release of the 2016 paper, the ABS undertook an extensive stakeholder engagement program (including the Reserve Bank of Australia, Department of Social Services, Department of Finance, Commonwealth and State Treasuries), a call for public submissions, and an external review of methods and data sources by price index and National Accounts experts.

1.4 Stakeholders and public submissions were supportive of the ABS proposal to annually re-weight the Australian CPI. Consultation with key stakeholders also raised additional topics for further ABS research. These topics included: methods and data sources to more frequently re-weight the SLCIs; and providing methodological clarity for the calculation of capital city weights in the inter-HES years. This paper presents concepts and methods (section 2), and empirical results (section 3).

1.5 The methods presented in this paper will be implemented in the December quarter 2018 for both the SLCIs and the CPI.

2.1 HES data provides weighting information for CPI and SLCI sub-populations, and will continue to be the principal data source for the CPI and SLCIs weights when they are updated for the reference period of the survey. The CPI population subgroups are the eight capital cities; the SLCI subgroups are Employee, Aged pensioner, Other government transfer recipients, and Self-funded retiree Households, as a weighted average of the eight capital cities. The next HES is scheduled to be conducted in 2021-22. Until then, the ABS will use HFCE data to annually re-weight the CPI and SLCIs. ABS research shows that annually re-weighting reduces the upward substitution bias that can emerge when expenditure weights are held fixed across a number of years.

2.2 Methods to align HFCE data to the CPI scope and concepts are outlined in ABS (2016), along with the approach to produce an annually re-weighted CPI. Since then, the ABS has further investigated two related topics to:
(a) annually re-weighting the SLCIs; and
(b) deriving capital city expenditure weights in inter-HES years.

2.3 The current expenditure weights for the SLCIs are derived from the HES. Weights for four household types are produced, based on the principal source of household income.

2.4 The SLCIs sub-populations are:
(a) Employee households - those households whose principal source of income is from wages and salaries;
(b) Age pensioner households - those households whose principal source of income is the age pension or veterans affairs pension;
(c) Other government transfer recipient households - those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension; and
(d) Self-funded retiree households - those households whose principal source of income is superannuation or property income and where the HES defined reference person is 'retired' (not in the labour force and over 55 years of age).

2.5 As is the case for the CPI, the SLCIs will be enhanced by more frequent weight updates. The key benefits from annually re-weighting the SLCIs include:
(a) maintaining coherence between the CPI and the SLCIs; and
(b) reducing substitution bias.

2.6 Annual re-weighting of the SLCIs utilising HFCE data requires a number of challenges to be resolved. The most significant challenge is that HFCE data for the sub-population is not available.

2.7 Following ABS investigations, the approach to annually re-weighting the SLCIs can be summarised as follows:
(a) Align HFCE data with the scope and classifications of the SLCIs at a detailed level.
This requires removal of some components of HFCE (e.g. expenditure by Non Profit Institutions Serving Households (NPISH)) to align with the SLCIs, and concordance of HFCE data to the SLCIs and to the CPI EC classification (ABS, 2016). This provides HFCE data for 2015-16 and 2016-17 for each EC of the SLCIs and CPI (with the exception of the mortgage interest EC in the SLCIs sub-populations, which is discussed in 2.9).
(b) Apply the movements in HFCE aligned data between 2015-16 and 2016-17 for each EC to update the expenditure weights (footnote 1) for the SLCIs sub-populations.

2.8 This approach assumes that annual movements in HFCE aligned data capture annual changes in expenditure in response to relative price changes or preferences across the four sub-populations. For example, if the relative price of beef increases, it is assumed that the four household sub-populations groups adjust their level of consumption and substitute to, for example, chicken or lamb, in a similar manner.

Special case - Housing (New dwelling purchase and Mortgage interest charges ECs)

2.9 As part of these investigations, the ABS addressed unique conceptual differences between the CPI and SLCIs. Specifically, within the Housing group, the New dwelling purchase by owner-occupiers EC measured in the CPI is based on the acquisitions approach, whereas the mortgage interest charges EC measured in the SLCIs is based on the outlays approach, see paragraph 3.5 (ABS, 2017b). The ABS has investigated this conceptual difference and determined that the scope and coverage of the dwelling interest charges from the household interest data in the Australian National Accounts (ABS, 2017c) aligns with the SLCIs mortgage interest charges EC. Therefore, National Accounts data will also be used to re-weight Mortgage interest charges in the SLCIs.

2.10 Empirical results of this methodology are summarised in section 3 of this paper.

2.11 National Accounts HFCE data is compiled at the national level (ABS, 2015a). This poses a challenge to derive expenditure weights for the individual capital cities. The ABS will address this challenge by:
(a) Applying the movements in HFCE aligned data for each EC to update the weighted eight capital cities CPI.
(b) Deriving HES based proportions for each capital city EC, using HES data of expenditure in each capital city to the weighted eight capital cities index for each EC.
(c) Applying these capital city proportions for each EC in (b), to the updated weighted eight capital cities index in (a) to produce capital city expenditure weights for each EC (footnote 2).

2.12 This approach assumes the following:
(a) no relative change in the expenditure proportions of capital city households relative to the rest of state households; this is implicit in applying National HFCE aligned data to the weighted eight capital cities; and
(b) for each capital city, ratios (in terms of underlying quantities) by EC are fixed for 6 years. This fixes the relative proportion of expenditure on, for example, milk by Sydney households relative to total milk expenditure by all capital cities.

The ABS will continue to monitor and test these assumptions each year. Where required, adjustments to capital city weights will occur by utilising alternative data and qualitative information to incorporate significant changes that apply to specific capital cities (e.g. a significant downturn in the housing market in one capital city).

1 Expenditure weights derived from the HES (in this case, HES 2015–16).
2 A detailed numerical example demonstrating this approach is presented in Appendix 2.

3.1 In theory, annually re-weighting the CPI and SLCIs reduces substitution bias. To test this theory, this section presents empirical results that compare: (a) the published SLCIs and CPI eight capital city indexes which have weights updated every 6 years with (b) annually re-weighted SLCIs and the CPI capital city indexes.

3.2 Empirical analysis of the SLCIs sub-population indexes shows that the annually re-weighted indexes record lower rates of growth over the analysis period (September 2011- September 2015); see table 1 below.

3.3 The SLCIs results are consistent with the findings in ABS (2016) that more frequent (annual) weight updates reduces substitution bias in the CPI. Table 1 shows that the cumulative increase in the price index is lower when weights are updated more frequently.

3.4 Empirical analysis of the eight capital city indexes, and the weighted average index also shows that the annually re-weighted indexes record lower rates of growth over the analysis period (September 2005 - September 2015); see table 2 below. Substitution bias is reduced for all the capital cities and the weighted average index.

3.5 The empirical results from this analysis support the proposed methods for the weight update of the SLCIs and the capital cities CPIs in the inter-HES years.

4.1 The “Enhancing Australia's CPI” program has provided an opportunity for the ABS to re-examine the frequency of updates to the CPI and SLCIs expenditure weights.

4.2 The ABS has conducted detailed investigations into increasing the frequency of EC weights updates by using HFCE data in the inter-HES years for both the CPI and SLCIs. These investigations address the various challenges in using HFCE data for these purposes.

4.3 The ABS has now completed further investigations, and provided empirical results that support the annual re-weight of the CPI and SLCIs in the inter-HES years using HFCE.

4.4 The ABS will update the Australian CPI and SLCIs expenditure weights using HFCE data in the inter-HES years, starting December quarter 2018.

4.5 User and stakeholder comments or feedback relating to this publication are welcome, and can be directed to details provided in the Preface section.

This release previously used catalogue number 6401.0.60.006.