That consumer prices are rising can hardly be news to anyone. It is enough to just go to the same supermarket several times over a month or two and note down the prices of several products.
You can then work out the differences between the dates with a calculator and get data about how the cost of living evolves over time.
That can be a good approach for a single consumer as you will take into account goods and services that are relevant to you.
If, however, another person decides to do the same thing, their results will probably be different from yours since they usually spend their money on different goods and services than you.
As a result, for each consumer, prices increase at their own rate and some may be more affected by their rise than others.
But what is then meant by the inflation rate which is published by the government every year and is supposed to be representative of the entire country?
That is going to be the topic of today's article. We are going to talk about how the inflation rate is calculated in more detail and try to understand why it is so important for the country's economy.
But before we look at the kind of data fed into the calculator by statisticians, let's first try to better understand what the inflation rate itself actually is.
And if you want to learn more about inflation in general, have a look at our article.
What does the inflation rate represent?
To better understand what the inflation rate really is, we need first to introduce another important concept which is the CPI (consumer price index).
The CPI is an index based on the prices of goods and services regularly bought by the average consumer in Australia during the year.
If the CPI at one moment of the year is much bigger than at another, it means that there is strong inflation in the country.
In order to establish the average basket of goods and services needed to collect data and work out the CPI with a calculator, statistics specialists try to single out the most common products for all Australians independently of their level of income and social background.
For example, the average basket of goods and services is likely to include bread, butter and milk, whereas the price level of sports watches or pool tables will probably be ignored.
This way, the CPI and the inflation rate if reflects will be representative of Australia as a whole and not just certain parts of the population.
It is important to understand though that the average consumer on which the CPI is based doesn't really exist, so the inflation rate for each individual will probably be different from it.
Unfortunately, working with various CPIs and inflation rates for different consumer groups would hardly be possible for the government and other public institutions as it would require much more time and would make decision-making too difficult.
So, when checking the inflation rate in newspapers or online, you should keep in mind that the real change in the CPI for you might be slightly different depending on what goods and services you usually buy.
You can find more detail about the definition of inflation on our blog.
Who is in charge of calculating the CPI?
If you try to follow the price of a particular product over a year or even a month, you will probably realise that it's a lot of work.
Now imagine that you have to do the same for thousands of items. That is truly a titanic task that, of course, can't be carried out by one person.
The organisation that the calculation of the CPI is entrusted to is the Australian Bureau of Statistics (ABS) and it takes care of all the stages of the process, from collecting data to processing it and feeding it into the calculator.
The ABS has hundreds of employees who actually visit different shops and markets to collect data and then it is registered in a database.
As it is still a lot of work even for an organisation, the CPI and the inflation rate are updated every three months and that data can be used to work out the inflation rate for the year.
The Bureau of Statistics' inflation calculator
A useful tool available on the ABS website is the inflation calculator. With its help, you can see how the value of the Australian dollar changed over the years, taking into account inflation.
For example, you can enter an amount of money, like 100 dollars, for the year 2010 and the programme will tell you how much money you would need to purchase the same basket of goods and services in 2020 or any other year.
Playing with the calculator can be a good way to become more aware of how inflation works over years and make the right decisions on saving or investing your dollars today.
Is calculating the CPI worth it?
As we have just seen, collecting data and working out the CPI involves a lot of work, which means that it has a cost. A question that a consumer and tax-payer could logically ask is whether it is worth it.
If the inflation rate were calculated only out of intellectual curiosity, it is true that we could deem its cost a bit excessive. However, the use of the inflation rate goes far beyond economic research and general knowledge.
One of the most important organisations needing the inflation rate for its work is the Reserve Bank of Australia.
As the central bank of the country, it is responsible for determining and adjusting the policy interest rate, and the latter is closely related to inflation.
In fact, when interest rates are low, the supply of money in the economy goes up, which can potentially lead to an increase in inflation.
On the other hand, if the central bank decides to raise interest rates, like what is happening today, it is likely to curb inflation.
Economists consider that the optimal level of annual inflation is between 2 and 3 three per cent.
Higher inflation would lead to a rapid increase in the cost of living and make ordinary people's life more difficult, whereas negative inflation would push the consumer to save their money and possibly cause stagnation in the economy.
That is why it is essential for the RBA to have exact data about the price level in the country and it fully offsets the cost of the ABS work.
In addition to the RBA, data provided by the ABS can be used by the government and other public institutions and is crucial to judge the health of the Australian economy in general.
Who suffers the most from inflation?
As we have said the CPI doesn't equally represent the entire population, so some of its parts must be more affected by rising prices than others.
As it happens, the economic group that suffers the most from inflation is the poor.
The inflation rate takes into account the most essential goods regularly bought by people and the poor turn out to spend a bigger share of their income on those products than other groups in the population.
On the other hand, the rich seem to be less affected by higher prices, since large parts of their income are spent on other commodities than those included in the CPI.
As a result, the real inflation rate for the poor tends to exceed that for the rich and that makes it even more important for the government to help them in difficult times.
Even a small amount of subsidies can help low-income families overcome the consequences of the rising cost of living and at the same time, it is likely to liven up the economy when that money is spent.
So, subsidies are good not only from an ethical but also economic point of view.
Staying informed about inflation
When we read newspapers or watch the news on TV, we often tend to skip the section on the economy. That is often a big mistake.
Learning about inflation and other economic processes can be crucial not just for businessmen but for all people.
We all have to decide how to spend our salaries, where to invest and what amount of money to keep as cash. Good planning can help you save a few extra dozens or even hundreds of dollars every year and improve your general financial situation.
What's more, once you've understood the basic economic concepts like inflation, keeping up with the business news can actually become entertaining and enjoyable.
That is why we recommend that you don't stop at inflation but keep exploring economics deeper and deeper. Lots of amazing topics are awaiting you and Superprof is always there to give you a hand.
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