Whether you are a business looking to maximise your profit or an individual keen to understand how inflation can impact your daily life and finances, having a basic understanding of inflation in Australia can be crucial for your success.
The annual rate of inflation plays a significant role in shaping the economy, and measuring inflation is crucial for policymakers, investors, and individuals alike.
We took a closer look at some of the key questions you may have about measuring inflation and calculating the change in inflation as well as all you need for a comprehensive understanding of inflation in Australia.
Let's start at the beginning: just what do we mean by inflation? In the simplest terms, inflation refers to a general increase in prices of goods and services over time, resulting in a decrease in the purchasing power of money. In short, inflation occurs when prices rise, meaning your money will not be able to stretch as far, and purchasing power decreases.
Measuring inflation is important because inflation impacts everyone; knowing when inflation levels are rising has a direct impact on the economy, wage growth rate, mortgage rates, energy prices, interest rates, investment decisions, and many other elements of everyday life. Inflation affects us all.
Loan rates will increase for both business loans and personal loan products, and even a small price increase on everyday essentials will have an impact on personal consumption expenditures.
Important: Monitoring and understanding inflation is crucial for economic stability and making informed financial decisions, including analysing and calculating the changes in the cost of living and the change in price of key goods.
In Australia, the Australian Bureau of Statistics (ABS) has always measured inflation. This body conducts regular surveys and collects data to calculate a range of measures of inflation - policymakers and economists then use these to analyse and manage the economy.
In Australia, price inflation is measured using two primary methods: the Consumer Price Index (CPI) and the Trimmed Mean Measure (TMM). Of these, the Consumer Price Index is the most commonly used and is the option typically used and recognised as the official method to measure inflation.
Note: The Trimmed Mean Measure is another alternative that excludes extreme price movements, which can help offer a better understanding of any underlying inflation trends and movements.
The CPI sees inflation calculated by measuring the change in the retail price of a fixed basket of goods and services that Australian households spend most on and most commonly consume.
The ABS calculates the CPI with a process that involves collecting the relevant price data for thousands of items across a wide range of categories, including food and energy prices, education, housing, transport, and healthcare, and measures changes. These prices can then be weighted and adjusted according to their priority in the household expenditure - that is, how important they are to the average consideration.
This data is then used in an inflation calculation to find the overall index.
The Trimmed Mean Measure is the second method of measuring inflation and focuses on the central tendency of price changes by deliberately excluding the most extreme price movements; the aim is to provide a more stable measure of inflation and how this changed over time.
By removing the impact of volatile price changes that result from temporary factors, such as sudden, unexpected disruptions to the supply chains or the onset of natural disasters - all of which can cause inflation -the TMM aims to offer a more stable overview and identify underlying trends and causes of inflation.
The TMM will measure the changes in the CPI's upper and lower tails, which usually incorporate the highest and lowest 15% of price changes. The ABS then averages the remaining price changes, resulting in the TMM.
In addition to the two main methods, the ABS also sees inflation measured using other options, including the Analytical Series of CPI, and the Weighted Median, which can add additional insight and provide policymakers with a closer insight into the overall economic environment.
Inflation data can be used by a range of parties, including policymakers and economists, to gain insight into the current status and health of the economy.
Institutions such as the Reserve Bank of Australia (RBA) also use inflation measures as a critical factor in determining monetary policy - this plays a crucial role in decisions surrounding interest rates.
Note: The aim of the RBA is to keep inflation within a range of 2-3% over the medium term; this is optimum for supporting sustainable economic growth and price stability.
As we have seen, understanding the effects of inflation and types of inflation measures is a crucial element of financial literacy. Its one of the key economic indicators that can help policymakers and economic experts make crucial decisions that impact the whole Australian financial system.
Individuals also benefit from an understanding of inflation and how it affects disposable incomes and price levels; this factor plays a key role in everyday life, so good base knowledge is crucial.
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Disclaimer: The author is not a financial advisor, and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not consider your investment objectives, particular needs, or financial situation.