Why the cost of living is rising

How can living costs be such an issue when the official measure of inflation, the Consumer Price Index (CPI), is so low? How can things be getting tougher when the Retirement Affordability Index™ for many tribes is negative?

Cost of living is just one side of the coin. What people are facing is record low income growth that is not keeping up with prices.

The cost of what you buy is only half the story. What people notice is not rising prices or rising incomes, but the difference between them. If incomes are rising faster than prices, then people are becoming better off. But if prices are rising faster than incomes, then people are worse off.

When prices rise faster than incomes, economists call this falling real incomes. Your real income is the volume of goods you can purchase. If real incomes are falling, then you are able to buy less and less with what you earn. Since 2013, real incomes have been going down.

When people talk about cost-of-living pressures, they’re really talking about low income growth not necessarily rapidly rising prices. Slow wages growth and low inflation means smaller increases in the Age Pension. (The twice yearly indexation of the Age Pension is based on two factors: price increases and male weekly earnings. Payment rates are indexed to the rise in the CPI or the Pensioner and Beneficiary Living Cost Index (PBLCI), whichever is greater.) So if prices and wages are growing slowly, then growth in the Age Pension will also be slow.

As a result, many retirees are dealing with sluggish incomes. This is exacerbated by the recent cut in interest rates because of the slowing economy. (The Reserve Bank of Australia (RBA) cut its official interest rate by 0.25 percentage points in June to a new record low of 1.25 per cent. It was the first change in the RBA’s policy setting since August 2016, and more cuts in 2019 are expected.)

The latest check of the health of the economy showed that economic growth had slowed to 1.8 per cent. It has not been this low since the Global Financial Crisis of 2007-08 and was enough to spook the RBA to cut interest rates.

This quarter’s Retirement Affordability Index™ has gone backwards for many tribes for the first time.

Negative inflation is an unusual concept. It basically means average prices are going down. But it doesn’t mean all prices are falling. Some prices are continuing to rise. What it does mean is that people in many of our retirement tribes are spending more of their income on items that are falling in price than on items that are going up in price.

The important thing to remember is that these are average price changes and averages need to be approached with caution.

If your feet were in the oven and your head was in the freezer, your average temperature might be normal, but you’re unlikely to be comfortable. Let’s have a closer look at the categories that experienced price drops.

Prices in a couple of key categories fell in the June quarter, mainly petrol and travel. Petrol has risen a lot over the past few years and, while it fell this quarter, it is still up on what it was at the start of 2016. So, while the fall in petrol prices is welcome relief, it certainly doesn’t mean petrol is cheap. And the bad news is that since the end of the March quarter, oil prices have risen and the Australian dollar has fallen, which means that the drop in petrol prices this quarter is unlikely to be sustained.

The other big price drop was in domestic and overseas travel. This had the biggest impact on the Affluent tribes as they spend more of their income on travel.

Affluent tribes saw their cost of living fall during the quarter, with couples experiencing a drop of 0.3 per cent and singles 0.2 per cent.

Falling travel costs had a moderate effect on Constrained tribes, who saw their cost of living fall by 0.1 per cent for couples and singles. They had the least effect on the Cash-Strapped, whose cost of living was unchanged through the quarter.

Just because average prices are falling, it doesn’t mean that some categories aren’t going up in price. Medical services, for example, jumped in price. Other areas are a bit more hidden. Electricity fell during the quarter but, as with petrol, the fall came after large price increases in the past few years. Filling up at the pump is still expensive and the electricity bill still looks large, even if prices fell during the quarter.

Even considering these categories, the cost of living for our retirement tribes over the longer term has been below the long-term average. In the past three-year period, the cost of living has gone up about four per cent. This is much less than the usual average of two or three per cent per year.

However, with income growth so low, even four per cent over three years eats into the household budget. With a weakening economy and little sign that incomes are going to start growing much in the future, we can expect things to remain tough for the foreseeable future.

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Written by Matt Grudnoff

Senior economist at the Australia Institute, Matt is a regular contributor to YourLifeChoices and has extensive knowledge on retirement incomes, taxation and tax concessions, the federal Budget, poverty and inequality, free trade agreements, housing affordability, energy economics and climate change. He worked at the Australian Bureau of Statistics and the Department of Climate Change. Matt is the brains behind Australia's most accurate cost-of-retirement table, the YourLifeChoices Retirement Affordability Index™.

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