According to the Reserve Bank of Australia (RBA), inflation is defined as an increase in the level of prices of the goods and services that households buy. Remember your grandparents telling you that milk used to cost 10c (or less!) a litre when they were kids? That’s an easy example of inflation at work.
One of the most common measures of inflation and its effect on the average consumer is the Consumer Price Index, or CPI.
What is CPI?
CPI measures the average change over time in the prices paid by households for a fixed basket of goods and services. In Australia, the CPI is calculated by the Australian Bureau of Statistics (ABS) and published once a quarter, with its principal purpose to measure inflation faced by households in order to support macro-economic policy decision making. In other words, to help the RBA manage the economy.
According to the ABS, the basket of goods and services contains representative items actually acquired by households. The actual items priced for the CPI basket are determined based on a number of factors. Items:
- must be representative of purchases made by the CPI population group;
- must be identifiable and specific commodities or services (for example, a 420g can of baked beans, or adult general admission to a football game); and
- are not excluded because of moral or social judgements
Almost 900,000 separate price quotations are used in the calculation of the CPI each quarter. This data is collected in a variety of ways, from ABS staff to transaction and administrative data. The changes in price of these goods and services are then combined with actual expenditure data from Australian households to calculate the overall price change in the quarter.
The ‘basket of goods and services’ that makes up the CPI measurement can be categorised into 11 key groups:
- Food and non-alcoholic beverages
- Alcohol and tobacco
- Clothing and footwear
- Furnishings, household equipment and services
- Recreation and culture
- Insurance and financial services
While it’s not the only measure of inflation, the ABS states that the CPI is the most comprehensive measure of goods and services price inflation faced by all consumer households.
Other price indexes produced by the ABS are suited to different parts of the economy; for example, the Selected Living Cost Indexes (SLCIs) are designed to measure changes in living costs for selected population sub-groups, while the Wage Price Index (WPI) measures changes in the price of labour in the Australian market.
You can learn more about CPI and how it’s calculated each quarter via the ABS.
How much inflation is good inflation?
No one likes things getting more expensive, so it’s understandable to think that no inflation is the goal. As it turns out, the RBA actually has an inflation target range of 2-3 per cent. According to the RBA, this target range is “sufficiently low that inflation at this level does not significantly influence people’s economic decisions”.
High inflation, of course, can be detrimental in a number of ways. According to the RBA, along with reducing consumer purchasing power, inflation being too high can also lead to diminished returns for investors, higher wage growth that may lead businesses to raise prices or reduce their workforce, and reduced competitiveness for a country in the global economy.
On the other hand, if inflation is too low this may also have a number of negative effects. For example, consumers may delay purchases because they expect prices to fall. Falling prices – a situation also known as ‘deflation’ – can then lead to lower spending, which may then lead businesses to reduce wages or let workers go, meaning further downward pressure on demand and prices.
Why we invest with inflation in mind
So, why is it important to consider inflation when investing? In the simplest terms, it’s because the buying power of your dollar decreases as inflation rises over time – remember that litre of milk that once cost 10c?
Given super is a long term investment, it’s important to ensure that the dollars you invest today will be able to support you decades down the line in your retirement, when the prices of the goods and services you buy are likely to have risen significantly from where they are now.
With this in mind, each of Qantas Super’s investment options aims to deliver a return over and above the long term CPI. For example, our Aggressive option aims to achieve a return that exceeds CPI by at least 4% per annum over a 10 year period, after investment fees and tax.
You can look at how each of our options are performing against their long term CPI objectives here.