Explainer - What is inflation and what's its impact?

Inflation is usually expressed as a single, average figure but inflation affects different people differently

In this first instalment of this new AIBE series, we explain what inflation is, how it is measured, why it matters, and how inflation affects different people.

COVID-related supply disruptions and the massive income support programs around the world have both put upward pressure on prices in countries around the world. The invasion of Ukraine by Russia has led to further disruption and large increases in the prices of oil, gas, and coal. As a result, we are now facing increases in prices that have not been seen in over a decade.

So, what is inflation?

Inflation is the increase in the prices of the goods and services households buy.

A key measure of inflation is the Consumer Price Index (CPI) calculated by the Australian Bureau of Statistics. The CPI measures the average change over time in the prices for a fixed basket of goods and services paid by households who reside in the eight State/Territory capital cities.

The CPI is how we keep track of the cost of living in Australia. It influences pensions and other government payments, interest rates and wages, but it can conceal a world of pain for individuals and families.

The CPI increased to 5.1% in the first quarter of 2022 compared to the same period last year. This is the highest annualised increase in a quarter since June 2001. 

What goods and services are included in the Consumer Price Index?

The goods and services included in the CPI cover a high proportion of consumers' expenditures.

There are 87 expenditure classes arranged in 11 groups with the aggregated weights for 2021 given by:

Income and standard of living

Australians rely on two main sources of income:

• wages and
• government income support schemes (e.g. pension, allowances, parenting payment, etc).

The Wage Price Index (WPI) is a measure of the increase in wages. The Department of Social Services (DSS) relies on Indexation Rates to adjust government income support schemes to account for changes in the cost of living.

For the year ending March 2022:

• WPI increased to 2.4%. This is a return to pre-pandemic levels and below historic levels.
• DSS set the indexation rate at 2.1% for most schemes.

Annual percentage growth in WPI, March 2021 to March 2022
^{Overall, government income support and selected industries}

^{Source: Australian Bureau of Statistics, Wage Price Index} 

What matters for the standard of living is real income:

• real wages declined by 2.6%
• real income support schemes declined by 3%.

As a result, the standard of living has worsened for Australians.

What does inflation mean for individuals?

Let's take all of the information above and apply it to 3 different situations to find an annual personal rate of inflation. We have used different sources such as the Census, the Australian Council of Social Service, CSIRO, and UQ student guidelines to make educated guesses about the different spending patterns for each person's situation. Australians allocate their income differently across expenditure classes depending on their persobal circumstances. For this reason, different people face different inflation rates.

Proportion (%) of income spent on classes of expenditure

7.3% for the average Queenslander

The average Queenslander according to the 2021 census is 38 years old and married with 2 children. This scenario assumes they recently bought a house with a mortgage, travel to work by car and have one child in childcare and another in state school.