CPI may understate the rising costs of retirement

At the risk of being howled down once again, a gold currency solves all the above problems. No inflation, no artificial indices of anything which are always produced too late to be useful, no requirement for a Reserve Bank. Australia is blessed by having plenty of the stuff. The problem is of course that government debt is not inflated away. It remains in gold with interest payable in gold. Just like HECS debt that we saddle our best and brightest with, difficult to pay back. It requires a discipline which no political party of either persuasion wants. Hard to believe, but, priced in gold, the value of a median priced house in Sydney has not changed much over the past 20 odd years, still at 400 oz, give or take.

David, one thing the gold standard does is impose monetary policy discipline. But it's impractical and not necessary. It lacks flexibility and really is arbitrary. (Why not some other commodity? There is nothing special about gold.)
We had good monetary policy discipline from the time inflation targeting was introduced in the 1990s, only faltering when the pandemic threw a few curve balls and central banks around the world mucked things up. But we don't need an ancient regime to be resuscitated to get policy discipline back.
Gold can be a reasonable hedge against inflation, but that isn't the reason a gold standard might be of value - it's the policy discipline angle that's important and there are better ways to get that.

What is special about gold? King Kroisos of Lydia in the 6th century BC is credited with introducing a bimetallic coinage, consisting of gold and silver. This invention spread like wildfire throughout the Greek world and then to the Romans. So much better and more portable than cattle of bushels of wheat, cowries, or paper and plastic. You only need a small amount of gold to have a lot of value. As the later alchemists, including Sir Isaac Newton, found out, you cannot make it from base metals. It has stood the test of time and for 2 and a half millennia was the money of choice. It is only the last 90 years that the experiment of worthless money has been carried out, and in my view it is an abject failure. So much for the "barbarous relic".
As for the policy discipline, I will believe that when I see it. At the moment all I see is the attempt to reduce the affects of policy induced inflation by penalising young couples trying to buy their home, and not having enough children to sustain Australia's population.

"only the last 90 years that the experiment of worthless money has been carried out":

https://en.wikipedia.org/wiki/History_of_Chinese_currency

Chinese for millennia have witnessed all forms of use and abuse of worthy and worthless money.

David, it's interesting that in the one comment you take a very long term view referring to Greek and Roman times, then dismiss the thought that monetary discipline could exist by referring to essentially the last 12 months!
Monetary discipline does exist - the debate on the front pages today is all about it! The RBA put up the cash rate, despite the discomfort it knew would be caused to a lot of people, because getting inflation down to a level which is actually price stability* is the discipline they follow. They lost sight of this for a while when the pandemic threw some curve balls, but for decades now monetary discipline has been enshrined in our policy-making process.

* read Bernie Fraser's articles on the RBA website from the early 1990's when the 2-3% for the CPI was chosen as being aligned with 'practical price stability'.

"gold currency solves all the above problems": Why did not all Argentinians rake up every Peso to buy standardised gold coins and use them for savings and trade? 'Gold may be purchased in Argentina in the same manner as anywhere else. Gold coins or bars may be purchased from local coin shops or dealers. Gold coin and bullion may also be purchased from online dealers.' https://goldprice.org/gold-price-argentina.html

Dudley, your comment on Argentina is relevant. Gold has been suppressed to the point where it is not in current use as money and therefore "difficult" for most people to comprehend. However, Argentina uses USD as a poor substitute for gold, as the peso is absolutely useless with over 200% inflation pa. I believe Argentina nevertheless provide a few lessons for Australia, the first being do not follow them down that path. The second lesson is the the two forms of money can work side by side, so if Australia allowed a circulating gold currency, it could function alongside the AUD. The value of both would be set, as now, by their respective markets, with no arbitrary rules trying to tie them. The only concession required from the tax law is that gold, being money, would not be subject to CGT, or GST.

"Gold has been suppressed to the point where it is not in current use as money":

Gold is not redeemable at a fixed exchange rate with $A, $USA or $ARS.
Gold is readily available in standardised money form, example 1 ounce Troy coin.
There is a history of limitations on gold ownership and trading in many nations. As also for cash.

In Aus, every large city has gold dealer shops. Buy with cash, sell with $ to bank account. Not a limitation to legal activity.

In USA every town with a population greater than a few thousand has gold shops. Buy and sell with cash on the knocker. No questions asked. Convenient to have a few gold coins in case credit cards malfunction. No requirement to declare gold arriving or departing USA.

In Argentina:
'Banco Ciudad is the only Bank left in the gold trade after the government banned the purchase of 99.99% certified pure gold for savings in July [2019]. The Bank sells it with a purity of 99.96%.' ... 'There is a 35% gap in prices to buy and sell physical gold in this Bank' ... 'The gold sold by Banco Ciudad is not recognised internationally'. Gold must be declared when leaving Argentina.

Dudley, the Chinese may have had low value cash for centuries, but they are making up for it now, as they are very avid purchasers of gold.

"making up for it now, as they are very avid purchasers of gold":

https://www.google.com/search?&q=chinese+fake+gold

Density of 97% tungsten + 3% rhenium, same as gold.

Alloy does not pass the bite test, or the ka-ching test.

Romans increased liquidity and induced inflation by diluting the 'solidus' to 'less-solidus'.

Yes, the CPI doesn't measure everyone's 'cost of living'. It's not meant to. It's meant to measure the rate of inflation across the whole range of consumer goods and services transacted in the economy. It doesn't measure my personal cost of living. Does that mean that anything in my personal financial dealings should be indexed only to what I spend money on? Heaven forbid! So why should any sub-group be singled out for having a policy calculation, like a pension, indexed to something other than the overall rate of inflation? Just because an index might exist doesn't mean that there's a case for it to be used! Once you start, where do you stop? An obvious argument that could start would be between self-funded retirees who are on a part-pension but can still afford overseas holidays versus those on full pension who, in most cases, probably can't. As for the use of the CPI as the official target by the RBA, it's important to understand that one of the reasons that the target has always been expressed as a range (2-3%) and that it's been over time ("on average over the cycle") is that the RBA and the government have always acknowledged that the CPI is not perfect as an inflation measure. Further, not having to hit an exact number allows the RBA to take other inflation measures into account - such as the trimmed mean that they look at, which does exclude one-off outliers that could deliver an unhelpful reading. And finally, it allows them to be very much aware of the fact that in Australia interest rates have a more pronounced effect on young home owners via mortgage rates than is the case in other countries. The RBA is not as naive or stupid as so many people seem to think! And let's clarify one point. The comment was made that the CPI is a fixed weight basket. Yes it is, but only for 5 years. The weights are reviewed on a 5 year cycle based upon the Household Expenditure Survey and GDP data that shows changes in what people spend their money on. If they didn't do these then the cost of mobile phones wouldn't be in the index, to give one extreme example. Far more important than trying to fine tune specific indices for different cohorts within the community is the goal of getting inflation down to the target range. It was around 2-3% for many years prior to COVID and we weren't having these discussions - at least not seriously - back then. Inflation is an insidious, negative outcome for almost everyone in the economy and needs to be kept in check by sound macroeconomic policies - especially monetary policy, but also fiscal policy and, in my view, specific regulations at times to limit bank lending when demand is running too hot. Let's support the RBA and encourage the government to work towards achieving that goal rather than resigning ourselves to returning to the days of high inflation and the erosion of wealth and living standards that it brings.

"Inflation is an insidious, negative outcome for almost everyone in the economy":

Deflation is much preferred - in the absence of negative interest rates.

The value of money improves with time without being taxed.

Those transforming work into $capital can save their way to home-ownership without mortgages and less tax.

The mortgage debt mountain erodes to hillocks.

Nonsense Dudley. Deflation means impoverishment of the population through falling incomes and rising unemployment employment. Stability of prices- as captured in 2-3 on average - is the best outcome.

"Deflation means impoverishment of the population through falling incomes and rising unemployment employment.": Nonsense. Deflation results in wages buying more. [Cheeep Chinese Products?]. Also stops the mortgage debt arms race that impoverishes the population. Two types of deflation: bad economy [reduced demand] or good economy [cheaper supply].

Dudley every actual experience of deflation.in the world has meant rising unemployment and lower income for producers including small businesses. Your comment applies to some individuals but not at a macro, or whole of economy, level.
This is the most common error I see in most popular economic discussions - the tendency to think that what works for a group works for the whole. It's called the fallacy of composition. One person standing on a stool at the football can see over others, but as soon as everyone does it then the advantage is gone.Same with wages in a deflationary environment - the whole crowd can't stand on a stool and expect any lasting advantage.

"every actual experience of deflation.in the world has meant rising unemployment":

https://www.investopedia.com/articles/markets/081515/how-inflation-and-unemployment-are-related.asp#toc-the-bottom-line
'the economy reverts to the natural rate of unemployment as it adjusts to any rate of inflation'

"lower income for producers including small businesses":

Lower prices is commonly due to increased productivity. A 4 function hand held calculator 50 years ago cost $2,000 in today's money; costs $2 today. Manufactures became more productive and sold in vastly greater volume. Small profit% * Big sales$ = more profit$.

The employment stimulation effectiveness of slightly easy money depends on the angle of repose of the debt mountain. When the steepness visibly threatens a debt-slide then pouring more money on makes the risk appear larger and leads to less employment. 2006.

" every actual experience of deflation.in the world has meant rising unemployment":

https://en.wikipedia.org/wiki/The_Great_Deflation

' The prices of most basic commodities and mass-produced goods fell almost continuously; however, nominal wages remained steady, resulting in a pronounced and prolonged rise in real wages, disposable income and savings'

OK Dudley maybe not literally "every". But read that wiki article and it points to the more typical deflationary periods like the 1930s.

And the 19th century example was not a period of policy-induced deflation. I stand firmly by my view that deflation is not a preferred outcome. The best outcome is price stability - or as former RBA Governor Bernie Fraser put it "practical price stability".

My main point however which you sidetracked the discussion from is that inflation is the least desirable of all outcomes.

I will say no more on this topic now.

"deflation is not a preferred outcome":

Banks do not like or want deflation as deflation is contrary to their instinct to grow their business through growth in 'mortgages under management'.

While the [mortgage] debt mountain is small or modest, with minimal risk of a debt-slide, adding to debt increases the amount of money that can be spent, or the increases the rate of turnover of money being spent, resulting in more spending in a year: bingo increased Gross Domestic Product (GDP). Inflation likely.

When the debt mountain becomes too large relative to GDP, and a debt-slide is either anticipated or actually occurs, then spending and lending/borrowing stops. GDP grow slows or stops or decreases. Deflation likely.

"inflation is the least desirable of all outcomes":

A little deflation or inflation is not harmful. A Mount Fuji scale debt mountain is more harmul as it builds and erodes at a generationsl time scale. Some generations benefiting others harmed.

Warren, many thanks for taking the time to comment on my piece. I greatly appreciate your opinion on the issue.

Just a couple of counterpoints for your consideration.

To clarify the matter of ‘fixed’ in my piece, my reference to fixed was to the quantity of goods and services in the CPI basket, not to the basket being fixed inter-temporally. I am well aware that the weightings between the 11 groups, 33 sub-groups and 87 expenditure classes change periodically, generally annually using HFCE data.

You will therefore note that the first table above is labeled ‘Current Weighting (%)’, and that the data therein was sourced from the latest CPI Weighting Pattern (released by the ABS on 28 February this year).

Also, while I respect your position on the CPI being a macroeconomic indicator for economy-wide inflation, it should be noted that on the issue of the exclusion of mortgage interest charges in the CPI, this change only occurred in 1997, primarily as the outcome of the 13th Series Australian Consumer Price Index Review conducted by the ABS.

The information paper accompanying that review is a treasure-trove of thinking on inflation at that time, specifically as between the three conceptual bases for a CPI measure; the outlays approach, the acquisitions approach and the cost-of-use approach.

I’ll not do a deep dive into the paper, but suffice to say that the differences in view we may hold on the matter can probably best be summarised by these quotes within it:

“Households tend to think about inflation in terms of changes in their living costs.”

“Economists, on the other hand, have a different view of inflation. From an economist’s perspective, inflation relates to the contemporary rate of change in the prices of goods and services.”

As to which is more pertinent, that depends on whether your concern is with the macro economy, or with the micro (household) economy. Yours, understandably, is with the former while mine is unashamedly the latter.

Just one response on the 1997 review. I remember it well. One of the reasons for the review was that the incorrect inclusion of mortgage costs in 1986 had played havoc with the volatility of the CPI. Yes, mortgage costs weren't in the CPI from 1949 until 1986, for good reasons. They were included in 1986 for poor reasons and that decision was, thankfully, reversed. One reason for me holding that view is that the costs of purchasing a house go eay beyond items that are genuine consumption. Mortgage interest is paying for both the acquisition of land and of the "bones" of a house to live in for many years. That is a capital item not a consumption item. It is purchading something that changes in value over time, whereas consumer goods effectively depreciate to zero value once purchased Add that to the confusing correlation created by cash rate changes and the outcome they're seeking to influence, and to me it wasva no-trainer back in 1997 for the mistake of 1986 to be corrected. Let me also say that I have a keen interest in the micro issues as well. It's good that the ABS calculates other indices. Knowing those differences can help with fiscal policy decisions that are primarily about the distribution of government spending. But I strongly oppose the use of those indices in tailoring spending escalation calculations for the reason I gave in my original note. I'm sure no one would argue for tailoring if their spending basket happened to generate lower rates of increase than the CPI.

I've kept our houseold expenditure on a spreadsheet for many years so it's easy to compare what we spent last year with any year in the past. Far more than price rises in food, insurance, utilities, petrol or anything else our biggest percentage increase has been in rates paid to the local government. In 2013-14 the rates bill was $3,920. Living in the same house, in 2023-24 we paid $8,840 in local rates, a 125% increase. Over 10 years rates have more than doubled for all households in the ACT because the local government decided to phase out stamp duty. With all the rates revenue flowing in the ACT Government budget deficit has blown out, it's interest debt has increased, housing is unaffordable for first home buyers, rates are rising annually and we still have stamp duty. Council/local government rates are a regressive tax that unlike income tax are not based on capacity to pay but on the assessed value of the land you live on. Many older people live frugally in modest homes on fixed incomes, but now on high value, high rateable land. Rising rates is a cost of living and the more rates rise in excess of income growth the tougher it is for everyone, especially pensioners and self-funded retirees. So please also look to local government expenditure as a major contributor to inflation and pressure on household budgets.

Tax on rented property: $6,785.00 / y

https://www.investmentpropertycalculator.com.au/online-ACT-land-tax-calculator.php?form_complete=1&land_value=600000&state=ACT#calresult

Me thinks that most "economic commentators" have the same 3 year marginal BEc as our PM and they missed the one lecture of how CPI is determined - from memory year 11 school Economics raised this same potential error source so it's hardly a shock. There is an opportunity to create an App where households could create a list of purchased goods and services prices which is joined to the monthly ABS collected price changes in their State and get their own CPI and use this when judging how badly the PM is managing their country.

Agreed.
My Govt Pension has risen by just under 12% across the last 7 years; about 1.7% per year.
If anyone in the ABS imagines my cost have risen by only this much, then the indexing process is either seriously adrift or simply irrelevant.
Harry, Thanks for the informative article,

The concern is that the media focuses primarily on one lever of economics. Monetary policy and as you have pointed out the flaws within CPI measures. You read very little on the other lever. Fiscal policy (ie Government spending). You could argue they are working against each other currently. RBA doing one thing and Governments spending like crazy. As we have seen monetary policy smashes the borrowers and is fresh air for investors.

All Governments need to start spending less. Federally, if this came with taxation reform all the better.

The crux is that our current system punsihes hard work and productivity and rewards passive income.

Brilliant commentary and seems to point to a question re the Reserve Bank interest rate settings. If the Reserve Bank uses CPI to adjust the official cash rate they are affecting many retirees far more than they realise- as well as the increased number of employed younger people struggling with housing costs. The impact is possibly broader now than in the 1990s with less affordable/social housing available than previously , a greater percentage of owner/occupiers with mortgages and many landlords increasing rents as their cost of funding rises with the significant increases since 2022