What if dwelling prices were included in the CPI?
- House price cycles are not captured in the CPI because the cost of land is excluded from the consumer basket.
- The CPI is a poor barometer of changes in the cost of living for people who don’t own a dwelling and aspire to purchase one.
- Consumer price inflation would look very different in Australia if the complete cost of a dwelling was included in the CPI.
The CPI is generally considered to be a de‑facto cost of living index. It is the measure of inflation that most policymakers and commentators refer to when making statements about changes in the cost of living. Real wages, for example, are calculated as nominal wages deflated by the CPI. But there is a massive flaw in using the CPI as a proxy for changes in the cost of living. The index ignores price changes in the single biggest purchase a person (or household) is likely to make in their lifetime – a dwelling. For households that do not own a dwelling and aspire to purchase one, the CPI is a very poor measure of changes in the cost of living.
In this report we look at the justification for the omission of dwelling prices in the CPI. We then create a theoretical CPI that includes dwelling prices for illustrative purposes. We conclude with a brief discussion on the relationship between monetary policy, inflation and house prices.