What Rising Inflation Means For Cost Of Living
Do we all need to be drinking instant coffee from now on? We explore cost of living, wage growth and discretionary spending in 2022.
Written by Victoria Kent, Senior Investment Specialist
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This information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs.
Remember when our former Prime Minister couldn't recall the price of a litre of milk? I have to confess to being equally in the dark. However, this is due to a dairy intolerance rather than sheer ignorance.
The cost of milk and other staples has been top of mind for many across the country. Add rising housing costs and record-level petrol prices to the mix, and you have biggest expenses for 2022 so far.
Australian economists measure these price increases in the Consumer Price Index (CPI); a measure of the average change over time in the prices paid by households for a fixed basket of goods and services.
The annual CPI inflation increased to 5.1% in the March 2022 quarter, indicating the cost of goods is indeed getting more expensive. In fact, the only goods to dodge a price rise this quarter was clothing and apparel.
How does CPI affect cost of living? It depends on a few factors, such as your:
standard of living
discretionary vs non-discretionary spending
wage growth
Let's dive in.
Standard of living
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While the cost of living describes the price of basic necessities, standard of living describes the level of wealth, comfort, and necessities available to someone based on their socioeconomic status and location.
High inflation environments tend to erode the standard of living.
The United Nations' Human Development Index (HDI) is one standard of living measure, which scores 189 countries based on factors including life expectancy at birth, education, and income per capita.
Australia ranks high in the HDI category – #8 out of the 189 countries and territories. While Australia’s standard of living fares well globally, there are wide gaps in standard of living within Australia – particularly between rural and metro areas.
People living in rural and remote Australia have lower incomes and net household worth in comparison to those living in metropolitan areas. Aboriginal and Torres Strait Islanders, of whom around 65% live outside the major cities, are disproportionately affected by poverty.
So, while a cost of living increase will impact standard of living across the board, some communities will feel the effects more than others.
Discretionary vs non-discretionary spending
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Discretionary items are those we have more choice over; non-essentials like hobbies, travel, or your Netflix subscription. Non-discretionary items therefore include essential goods and services such as food, automotive fuel, housing and health costs, which have all experienced price rises through the year.
Non-discretionary annual inflation was higher than the CPI, and more than twice the rate of discretionary inflation – meaning the goods we need to buy are getting more expensive.
This especially impacts low-income households. If prices rise, they feel it the most since they have to spend a larger part of their budget on non-discretionary items like food or petrol.
Wage growth
It’s important to keep in mind price hikes in consumer goods won’t hurt people’s finances so long as wages go up, too. Therefore, it’s important to compare wage growth (WPI) with the CPI. That way, we can see if households have the ability to keep pace with inflation.
The WPI measures the changing price of labour, or fluctuating household incomes, in a few different standardised sectors. In a similar manner to the CPI, the WPI follows price changes in a fixed "basket" of jobs.
Unfortunately, the Australian Bureau of Statistics (ABS) has revealed wages have grown by 2.4% over the past year to March 2022, but it's less than the amount prices have grown over the same period (5.1%).
This means 'real' wages (accounting for price inflation) fell by 2.7%. When prices rise but wages don’t rise fast enough, the average person will have more money going out than coming in.
In order to stay in the black, many people will have to cut back on their discretionary spending, which may negatively impact their standard of living.
It might be a good time to consider swapping barista-made coffee for the occasional instant brew.