Uncertainty and inflation: Westpac's Justin Smirk

Guest Observer

RBA Deputy Governor Guy Debelle says that the reweighting of the CPI has, in the past, resulted in a lower rate of inflation.

In the 7th Warren Hogan Memorial Lecture, RBA Deputy Governor Guy Debelle gave an insightful and pertinent talk on uncertainty and its impact on monetary policy (see “Uncertainty”). 

But following on from yesterday’s weak CPI update, which suggested the Australian economy may have entered a “lowflation” trap (see “Inflation has gone AWOL”), we found it interesting that Dr Debelle took some time to outline how the reweighting of the CPI is likely to lower the current pace of inflation.

The ABS will very shortly update the expenditure weights in the CPI. Because of substitution bias, history suggests that measured CPI inflation has been overstated by an average of ¼ percentage point in the period between expenditure share updates. While we are aware of this bias, we are not able to be precise about its magnitude until the new expenditure shares are published, because past re-weightings are not necessarily a good guide. It is also not straightforward to account for this in forecasts of inflation. However, from a policy point of view, the inflation target is sufficiently flexible to accommodate the bias, given its relatively small size.”.

Readers may remember that back in September we released our research that suggested the reweighting to the CPI could lower our forecasts for the annual pace of headline inflation to end of 2018 by up to 0.4ppts (see “Upcoming CPI reweighting to lower inflation”).

Our current bottom up forecasts out to end 2019 are based on our projections for the individual components of the CPI using the current weights in the CPI. We will be updating our forecasts, using our best estimate of how we think the weights will change, in the November Markets Outlook publication.

 

Tags: 
Westpac Inflation

Comments

Be the first one to comment on this article
What would you like to say about this project?