1. In Australia, policy makers see price stability
as a crucial pre-condition for sustained growth
in economic activity and employment. This policy
focus on maintaining low levels of inflation
begs the question of the measurement of inflation
- the statistician's role.
2. Unlike, say, national accountants whose
work is based on agreed international statistical
standards, prices statisticians do not have
the luxury of an existing internationally accepted
set of concepts and definitions to underpin
3. However, in recent years there has been
increasing international attention directed
towards developing new approaches to the measurement
of inflation. A number of overseas statistical
agencies have been undertaking work in this
area. The Statistical Office of the European
Union (Eurostat) has been working on the development
of harmonised indexes of consumer prices for
member states of the European Union to support
the assessment of the effectiveness of member
states in achieving the required goal of price
4. The Australian Bureau of Statistics (ABS)
has undertaken some ground-breaking developments
in this important field of statistics. Our proposals
are described in an information paper entitled
An Analytical Framework for Price Indexes
in Australia (Catalogue no. 6421.0) which
was released in February 1997.
5. Our work on inflation measurement coincides
with our periodic review of the Australian Consumer
Price Index (CPI). This is in fact the thirteenth
such review since the CPI was introduced as
a periodic chain-linked index in 1960.
6. This paper begins by summarising the issues
under consideration in the CPI review and then
discusses our work on inflation measurement.
The current review of
7. The Australian CPI was first introduced
in 1960; it was preceded by a series of indexes
starting in 1912. The CPI, and its predecessors,
were designed to measure changes in the purchasing
power of wage and salary earner household incomes.
It has its origins in the highly centralised
wage setting arrangements which prevailed in
Australia until quite recent times.
8. In order to ensure that the CPI remains
representative of the spending patterns of the
reference population, the expenditure weights
which underpin it are updated about every 5
or 6 years. During these reviews we take the
opportunity to look at other aspects of the
CPI as well.
9. Although the CPI has been increasingly
used as a measure of household inflation, the
current Australian CPI was originally designed
as an input to the income adjustment process
and thus reflects changes in the purchasing
power of household incomes through adopting
an outlays or payments approach.
As such, it has conceptual limitations as a
measure of inflation, in particular through
the inclusion of mortgage and consumer credit
10. At the time of writing this paper, the
ABS is in the latter stages of the consultation
process associated with a comprehensive review
of the CPI. Perhaps the most important single
aspect of the review is deciding what is the
principal purpose of the CPI. That, in turn,
will determine what the CPI should aim to measure
and hence the most appropriate conceptual approach.
To facilitate user consultation on this, and
other key issues, an information paper entitled
Issues To Be Considered During The 13th Series
Australian Consumer Price Index Review (Catalogue
no. 6451.0) was released in May 1997.
11. Other issues addressed during the course
of the review include:
the frequency of compiling and publishing
the CPI. The current index is produced on a
quarterly basis, whereas the majority of OECD
countries produce monthly measures.
- the population and geographic
coverage. The present population coverage
is households with at least 75% of their income
from wages and salaries, but excluding the
top 10% in terms of income, in the eight capital
cities. The restricted population coverage
reflects the historical use of the CPI in
the wage and salary determination process.
Given the wider use now made of the CPI, it
seems appropriate to extend the coverage to
include all households in the eight capital
cities of Australia.
- the commodity classification.
The main proposal being considered is to restructure
the commodity classification to create a ninth
major group, "Financial charges".
- increasing the commodity
coverage. It is proposed to introduce bank
fees and charges, domestic and household services,
tertiary education fees and home computers
and software into the index, but to continue
to exclude, on practical grounds, gambling.
12. The ABS benefited from the deliberations
of a CPI Review Advisory Group, comprising major
13. At the time of writing the ABS is finalising
its decisions on the 13th series CPI. We expect
to announce these decisions in an information
paper to be published in the second week of
Inflation - what is
14. Before trying to measure inflation, a first
step is to define the concept. Economists have
variously described inflation in terms such
- "a process of continuously
- "a rising general level
- "continuously falling
value of money"
- "an increase in the quantity
of money circulating in relation to the goods
available for purchase"
- "a fall in the purchasing
power of money".
However, despite the fact that the term "inflation"
is used universally, the concept is rather nebulous
and there is no precise, generally agreed definition.
A framework for measuring
15. As a result of the heightened focus on
inflation, and recognising the conceptual limitations
of the current CPI as an inflation measure,
the ABS has undertaken a major study to develop
an analytical framework to support the measurement
of inflation. The results of this work have
been published in the analytical framework information
paper referred to above.
16. In the context of the lack of a generally
agreed, precise macro-economic definition of
inflation, the ABS has developed a "market transactions"
approach to the construction of price indexes
designed for the analysis of inflation. This
approach is based on the premise that inflation
in an economy is a phenomenon peculiar to the
operation of markets: that is, that inflation
results from the interaction of demand and supply
factors in the market place.
17. However, in order to build up meaningful
aggregate measures of inflation, it is necessary
to conceptually allocate all the individual
market transactions to specific markets as shown
in Diagram 1 below. It is not valid to simply
aggregate all the transactions taking place
in the economy because of the distortions that
would result from multiple counting as commodities
flow through different stages of the production
18. The diagram shows the proposed categorisation
of markets providing a broad level representation
of all market transactions involving Australian
residents. Each of the specific markets is shown
in the lower part of the diagram, with summary
aggregations of the markets in the upper part.
19. In theory, each of the markets shown in
the diagram could be represented by a price
index. However, the economic meaning of price
indexes corresponding to such aggregations of
market activity as Total Domestic Purchases
and All Transactions is dubious as
they would involve multiple counting through
including a combination of intermediate and
final transactions; they are shown here for
illustrative purposes only. Rather, it is more
meaningful to consider the market transactions
framework as providing alternative, but complementary,
views of the economy through different markets.
DIAGRAM 1 : MARKET TRANSACTIONS
VIEW OF THE ECONOMY
Reproduced from: Australian Bureau of Statistics,
Information Paper: An Analytical Framework
for Price Indexes in Australia (Catalogue
20. The first price index that could be designed
for the analysis of inflation is the
Price Index of Domestic Final Purchases.
21. The scope of this index would reflect purchases
by Australian residents, including prices of
imported items. The measure would be based only
on final market purchases, excluding
all intermediate purchases. As such, the index
would relate to the markets represented by "Domestic
final purchases" in Diagram I and include both
final consumption purchases and capital investment
- an economy-wide inflation measure.
22. Under the Domestic Final Purchases model,
separate price indexes would be available for
consumption and capital purchases, split between
the different institutional sectors defined
in the international System of National Accounts
(SNA), ie households, corporate (private and
public), government and non-profit institutions
serving households (NPISH) sectors. These components
could be disaggregated further to provide price
indexes for key subcomponents under alternative
23. Although it is intended to develop the
full economy-wide Domestic Final Purchases index,
the ABS will initially concentrate on the development
of the major component (about two thirds by
Price Index of Household
24. The Household Consumption Purchases
Price Index would differ from the current
CPI in the following main ways:
- interest rates (mortgage
interest charges and consumer credit charges)
would not be included as they do not directly
represent market prices for actual transactions
in goods and services; and
- payments for goods and
services which are purchased by households
at non-market determined prices (eg. public
education and hospital services) would not
25. Because we see inflation as a phenomenon
of markets, coverage of the household inflation
price index should be confined to actual markets,
where goods and services are exchanged at prices
determined by the interaction of buyers and
sellers. Goods and services which are acquired
free of charge or at non-market determined prices
should be excluded.
26. The main general categories of goods and
services which may not have market determined
- those which are provided
by general government (eg. defence, public
- those whose production
cost or prices are partly subsidised through
government funding (eg. pharmaceuticals);
- those which have prices
regulated or affected to a large degree by
government policy (eg. motor vehicle registration).
These types of goods and services would need
to be examined closely before decisions could
be made as to the boundary of the market determined
27. Because of the increasing interest that
policy makers have shown in measures of underlying
inflation in recent years, the ABS plans to
provide for the separate analysis of the effects
of changes in government taxes and charges on
the Household Consumption Purchases index. This
will involve separating the transaction prices
that are covered by the index into the market
component and the tax component. Then, specific
adjustments will be made to the index in order
to remove the effects of changes in the indirect
tax rates and produce analytical index series.
Such measures, known as "net price indexes",
are already produced in a number of other countries.Price
indexes under the Domestic Final Purchases model
form part of the broader market transactions
statistical framework which embraces a wider
family of price indexes. Complementary views
of inflation are provided by the Stage of Production
producer price indexes (discussed below), the
Labour Cost Index and the existing Export Price
28. The Labour Cost Index, which is
currently under development, relates to wage
and non-wage labour costs incurred by employers.
Initially the index will be confined to wage
costs. Wage costs are an important determinant
of general price change and so play a key role
in any framework of price measures.
29. The Export Price Index relates
to exports of merchandise from Australia. The
valuation basis is f.o.b. at the main Australian
ports of export. While changes in prices of
exports do not figure directly in the inflationary
experiences of Australian residents, they can
have significant second round effects as fluctuations
in export incomes impact on the demand for domestically
produced and imported goods and services. The
Export Price Index is therefore also an important
element in this broader framework.
30. As the scope of the Domestic Final Purchases
model is confined to final transactions,
it cannot provide a complete picture of the
price experience of the economy. Some users
are interested in price indexes which enable
identification of price pressures arising from
intermediate transactions, thus potentially
identifying early inflationary signals. Such
a complementary view is provided by the indexes
under the Stage of Production model.
31. The Stage of Production producer price
indexes will relate to the selling prices
of the output (initially goods only) of Australian
industries at basic prices. That is, they will
be output indexes viewed from the producers'
perspective. The aim is to augment the analytical
value of the current range of partial producer
and international trade price indexes through
their presentation in an economy-wide framework.
32. The commodity flows will be categorised
according to their economic destination on a
sequential basis along the production chain.
The basis for the categorisation is the Australian
Input Output tables. The primary index classification
will be into final goods (ie. goods destined
for final consumption, capital formation or
export), and intermediate goods (ie, goods that
flow into intermediate consumption for further
processing). To aid analysis, the intermediate
goods will be further split on a sequential
basis between first stage and second stage intermediate
goods, thus providing three stages of production.
Note that indexes for each of the three stages
are not aggregated, thus avoiding the issue
of multiple counting of transactions.
33. Under this model, "first stage intermediate
goods" are used in the production of "second
stage intermediate goods"; in turn, "second
stage intermediate goods" flow into the production
of "final goods". For each of the three stages,
separate indexes will be presented for domestic
production and imports. The "final goods" will
be further split into capital goods, consumer
goods and exports.
The present ABS position
34. In summary, the ABS is currently in the
The consultation process associated with a
comprehensive review of the current CPI is close
to being completed. The most important decision
relates to deciding what is the principal purpose
of the CPI, what it should aim to measure and
hence the most appropriate conceptual approach.
The results of the review are expected to be
announced in November.
A comprehensive consultation process on the
inflation measurement proposals contained in
the analytical framework information paper concluded
there is broad user support for the initiatives.
Forward work program plans and priorities are
being developed to accommodate these developments.
In parallel, the producer price indexes will be
re-cast in a Stage of Production framework to
support the potential identification of upstream
inflationary signals. Major coverage gaps will
be progressively filled.
- Initial work will focus
on developing the Household Consumption Purchases
index, including "net price index" analytical
series in which the effects of changes in
indirect tax rates are removed. This will
help in the analysis of underlying
- Indexes for the other
components of the Domestic final purchases
index will also be developed in order to provide
a broad, economy-wide inflation measure.
We believe that, through these initiatives,
a significantly improved service will be provided
to users in this vitally important field of
35. For further information on the
issues discussed in this paper, please contact:
First Assistant Statistician
Economic Accounts Division
Australian Bureau of Statistics
PO Box 10
BELCONNEN ACT 2616
Telephone: + 61 2 62526035
Fax: + 61 2 62531051
Australian Bureau of Statistics