Inflation Indexing Is A Scam

The Government Has Been Lying All Along

Have you ever wondered how certain prices of things keep going up but you look at the CPI as posted by the government and it says something like 3%, and you wonder, what's deflating in price to compensate for the 10% rise you saw in the prices of say, everyday groceries? I have. If there's one thing that hasn't made any sense at all, it's been the inflation reports on things that people buy the most - food and rent.

Here's an article in the SMH that basically confirmed my worst suspicions about the Government.

In the 1980s, the World Bank and the International Monetary Fund (IMF) put pressure on governments in the developed world to rein in inflation and labor costs. These governments had - and continue to have - huge unfunded future pension and healthcare costs which cloud their economic future.

They were encouraged in the early 1990s to bring in a new form of CPI that ensured reported inflation remained within a tightly targeted range of 2%-3%.

This included Paul Keating's Australia. The new index would not be a CPI - which simply measured changes in prices - but rather a National Affordability Index which measured how well all households collectively could afford goods.

Inflation had historically been overstated, contended the IMF, and contained an ''upside'' bias thanks to a number of factors: principally the qualitative improvements in goods and the ''narrow'' income base (that is, wages and salaries) upon which changes were measured. It was not broad enough, supposedly.

The case for qualitative improvement in goods was that the latest model TV may well cost more than an older one, but it had greater functionality.

Under the new measure, the two could not be compared without making an adjustment. A notional historical value for the new TV had to be determined - and here began the mathematical gymnastics - and then converted into an effective net present dollar value which was then compared against the old price of TVs.

According to the ''narrow'' income base argument, rather than just using wage and salary income purchasing power, all households' incomes should be calculated when measuring the economy's purchasing power.

This seems simple enough.

In practice, however, the top 15% of tax payers pay nearly 50% of our income taxes and this same group represents more than 60% of all consumer consumption in our economy.

By including all of this additional purchasing power when calculating the new ''average national affordability index'' you end up with some significant distortions, or ''downward bias''.

Urged on by the IMF, a rash of world governments adopted this new framework in the late 1990s within a matter of months of each other. All G20 nations now use it. They did this so they could start reaping the economic benefits.

*Ugh*. I do begroan with all! The top 15% of tax payers determining 60% of consumer expenditure pattern has to be one of the biggest skews in a statistical analysis of pricing. It means it includes price fluctuations of things like a 7 series BMW or a Rolls Royce in amongst the prices of staples such as poultry or bread or vegetables.

To make things more clear, check out this section:

As an example of how removed from reality the ABS calculations and assumptions can be, imagine that a loaf of bread costs $5 and you buy four loaves a week. If it cost $3 previously, you would be worse off to the tune of $8 a week. The ABS, however, might argue that you are in fact better off and that inflation has fallen.

The ABS could assume under their new calculations that, at $5 a loaf, we would only buy three loaves a week instead of four loaves thereby saving $5.

This is known as a quantative assumption. Quantative assumptions, though, are based on consumption trend data that is 12- to 18-months old.

Further, the ABS may assume that another less-price-inflated item is substituted for another loaf saving you another $2.

The problem, as you can see, is that we are talking about a loaf of bread here, a staple product, not a plasma TV set.

This is called a ``substitution assumption'' and it is based on an arbitrary estimate, or guess. (The ABS would prefer to call it a well constructed and tested mathematical model based on real world data. and so forth).

This can have a profound effect on what is known as the basket of goods (the set of basic groceries that the ABS uses to determine food price movements) and an equally profound effect on the final new CPI number.

''The ABS is basically free to play around with what is in the basket until they can model the right number,'' says Beavan.

Further, the average net household income has been driven up by the explosion in executive and upper-echelon pay packets, so you could say that multi-million dollar CEO bonuses drive up the national average income, meaning there is more money available to pay for goods so the goods are now more affordable - although the local pre-school and the average pensioner has not seen a cent.

*Ugh*. You wonder why we don't take to the streets with pick axes. It's because we have mortgages - I don't, but most of the self-respecting population does. But when they do get kicked out of their situation, they might invest in some pitchforks and torches and go witch-hunting for the idiots who came up with this indexing system.