As inflation continues to sting, Kiwibank economist Sabrina Delgado explains who is being stung the most.
In a world dominated by headlines about inflation, the past couple of years have been nothing short of a cinematic saga for the economy. Just a few weeks ago, the latest inflation data had us on the edge of our seats. Those headlines read “Inflation now at 4.7%. Still a ways away from the Reserve Bank’s 1-3% target, but a far cry from the 7.3% peak we saw in June 2022.” It’s been much of the same for a while now. Yet, even with all this talk on inflation, the experience of it across different demographic groups receives far less limelight.
When we hear or talk about inflation, attention usually goes straight to the headline number. The one you hear all over the news every three months. And that’s measured by what us economists call the Consumer Price Index, or CPI for short. In normal people speak, that’s just a measurement of the change in prices experienced by the average household.
It’s a glorious measure – one which us economists live and breathe –but it has a very significant shortfall. It measures inflation for just the average household. And behind every “average” is a whole spread of data. A distribution which in a country as diverse as Aotearoa, is sure to be vast, and largely unreported.
The CPI measures changes in the price of a representative basket of goods and services over time. But of course, not everybody’s basket looks the same, at any point in time. Some items, like food or rent, may hold a larger weight in the basket for some groups than others. And the different basket compositions means inflation is not experienced the same across demographic groups.
Cue the Household Living-costs Price Index (HLPI). Stats NZ’s solution to capturing a wider picture of inflation among groups of households. Giving greater insight into the inflation experiences of just 13 different household groups, it’s still no perfect measure. Nonetheless, it opens up an avenue to some pretty important stories hidden within the usual headline inflation number for Māori, beneficiaries, superannuants, as well as five expenditure groups and five income groups.
It should be noted that there is one distinct difference between the CPI and HLPI.
The HLPI includes mortgage interest repayments, while the CPI doesn’t. The CPI instead tracks the cost of purchasing new dwellings (excluding land). It’s a difference between the two that comes down to a design choice based on the intended purpose of each measure. Including interest repayments as part of the HLPI better aligns with its purpose to report on different household inflation experiences. While the CPI on the other hand, used for monetary policy purpose, excludes interest repayments to avoid circularity within the measure.
A plot twist in our inflation story
Across economic discourse there’s a common rhetoric that households with lower economic living standards are the most vulnerable to inflation, and there’s a number of reasons why. Primarily, most of their incomes tend to be spent on necessities, leaving little leeway to simply reduce spending. At the same time, they’re also likely to have less flexibility in the items they consume. For instance, when prices rise, it’s common to see households react by consuming cheaper items, and cutting back on non-essential goods. But in many cases, those with lower incomes are already consuming the cheapest products.
Prior to 2021, the low expenditure quintile experienced the highest inflation, while the higher expenditure quintiles experienced the lowest inflation. It’s unfair. Inflation discriminates and can worsen inequality.
Looking at the data today however, we’re seeing the opposite. Of all the groups, households in the highest expenditure quintile have been facing the highest inflation. Having peaked at 9.4% in December 2022, inflation for those in the highest expenditure quintile has now eased to 7.3%. Meanwhile those in the lowest expenditure group have had inflation ease to 6.6% after averaging ~7% for much of 2023. It’s an unusual plot twist. So, what’s different this time?
The answer is right in front of us.
The RBNZ has delivered the most aggressive tightening cycle in our history. Interest rates were lifted higher and higher in order to bring down inflation. The official cash rate increased 525bps in just 19 months. That’s fed through to all interest rates in the economy. And it’s those in the highest expenditure group, with higher levels of debt, that are feeling it the most.
For the highest expenditure groups interest repayments have a 9.6% weighting towards their cost of living. Whereas the lowest expenditure group has a weighting of just 2.3% on interest repayments. So, it’s no surprise to see interest repayments contributing a solid 3% to the highest expenditure group’s inflation.
Meanwhile for those in the lowest expenditure group, it’s rents and food prices that are contributing the most to inflation.
Now, you might be wondering why we’re focusing more on expenditure groups rather than income groups given that they’re both covered in the HLPI. And It boils down to household expenditure being a better proxy for living standards. Taking into account that a certain percentage of the population don’t have steady streams of incomes and that consumption expenditure fluctuates less than incomes, studies suggest household expenditure as a better measure of living standards than household income.
Beyond the expenditure groups, living costs for Māori increased 7.1%, down from 7.4%. While living costs for beneficiaries and superannuants were up 6.2% and 6.1% respectively. With lower levels of debt, superannuants and beneficiaries are not facing the same pinch from higher interest repayments as others. And all up, of all groups, superannuitants are facing the lowest inflation. But much like the lowest expenditure group, superannuants and beneficiaries have housing and food as the main contributor to their inflation. Based on the 2023 weights, housing inflation is contributing around 2.3% towards the total inflation felt for both beneficiaries and the lowest expenditure groups. Māori instead have higher interest repayments followed closely by housing as the leading contributors towards their higher cost of living.
The underlying theme is clear. When inflation was at its peak in June 2022, rising transport prices, due to supply chain disruptions and the war in Ukraine, were having the largest impacts across households. Today, it’s all about interest repayments and housing. Generally speaking, those with higher levels of debt have interest repayments as the largest contributor to their current cost of living. While those with lower levels of debt are being hit harder across housing and food.
Relief to come
Thankfully, relief is on its way. Inflation has eased and continues to decelerate. And as inflation comes down, living costs will follow. Housing inflation, particularly rents, however have some upside risk. With record levels of migration, compounding a housing shortage, rents have accelerated and remain above pre-Covid levels. On the other hand, the RBNZ’s heavy handed hikes are already having a meaningful impact. Because interest rates are a major contributor to the cost of living of many households. It’s further evidence that no more tightening from the RBNZ is needed. Should the economy continue to develop in the way we expect, inflation will drop back within the RBNZ’s 1-3% target band in the second half of this year. At that point in time, we think the RBNZ will be in a position to cut rates, hopefully from November. Rate cuts will help relieve the significant financial burden on all households, especially those who have only recently entered the housing market.
It should be noted that this article has discussed the level of inflation faced by different households, and this should not be confused with how well any group can absorb these price increases. Those in the higher expenditure groups may have larger cash buffers to get them through a period of high inflation, which can make all the difference versus those living paycheck to paycheck.