For decades, both the Reserve Banks of Australia (the RBA) and New Zealand (RBNZ) have been making decisions about interest rates based on incomplete inflation figures.

The problem is not, as commonly proposed, that house prices are excluded from our measure of inflation – the Consumer Price Index (CPI) – but we mistakenly omit a sizeable chunk of economic activity from our measures. In Australia, this omitted economic activity was valued at $168 billion or 8% of GDP, in 2020/21 alone. Importantly, this is not a mistake shared by other countries.

If this problem was fixed, we would have seen Australia’s inflation during mid-2020 reach 0.7%, a full percent higher than the -0.3% published by the Australian Bureau of Statistics (the ABS). Today, applying the same fix would see inflation at 5.2% and not the 6.1% published. Likewise in New Zealand, the latest inflation figure would be 6.5%. Uncomfortably high, but not the 7.3% published by StatsNZ for June 2022.

Had we gotten it right, interest rate cuts would not have been as deep in 2020 or would we not be forced to increase interest rates so drastically now. Governments too would have been less pressured in propping up the economy to such a dramatic extent, had they had access to this data. As an example, the NZ Government has now spent between 5-8% of GDP, for three years straight, on the COVID-19 Response & Recovery Fund. That amount of additional funding almost looks like wartime spending.

This error in calculating inflation has caused official figures to be more volatile than more accurate measures, which has been reflected in more volatile decision making than otherwise would have occurred. Reactive and volatile decision making is something, I am sure, we could do without.

Luckily, there’s a simple fix, with global precedent and we don’t have to throw the baby out with the bathwater.

Let me introduce you to the concept of imputed rent. Like rent paid by tenants to landlords, imputed rents are an owner occupiers equivalent of rent paid to themselves. To exclude it from the CPI is an error, one not made by other countries. Across the Pacific, the US includes imputed rents in the CPI. So important are their inclusion that imputed rents account for almost a quarter of their entire index weight.

Why does Australia and NZ exclude imputed rents from CPI, when other countries included them?

StatsNZ and the ABS say we exclude imputed rents because they are not an arm’s length transaction between parties, and therefore do not meet their strict standards for inclusion. A purist would find that hard to disagree with – but a purist could also argue that the CPI should reflect the same items used in GDP figures. A paradox, as imputed rents are a critical part of GDP.

Sounds needlessly abstract, hey? Some may ask if such technical questions even matter.

They certainly matter to the recent first home buyer, who may not have been sucked into a buying at artificially low interest rates, and now seeing repayments increase more than they otherwise would. It matters to old mate up the road, who is suddenly seeing their real wage and buying power decline at a pace not seen for decades, because our collective economic response to the pandemic was overcooked and stoked inflation.

The hubris of fiscal and monetary policy decisions made in 2020 have real implications for the economy today.

How can we do it differently?

Luckily, the openness, transparency, and integrity of our statistical agencies on both sides of the Tasman, and in the US meant I was easily able to create a CPI that includes imputed rents, using readily available information from their websites. Kudos.

Charts 1 and 2 show Australian and New Zealand Shows my recreation of the CPI including imputed rents, shown against the officially published figures. You will notice that in both instances, inflation during 2020 was higher than officially stated, and is now lower in 2022. Particularly in Australia’s instance, the inclusion of imputed rents would have been a stabilising influence on the index over the past few decades – and perhaps too on the decisions made using those figures.

In New Zealand, the CPI would have been consistently higher over the past decade – the impact that surely would have been noticed by the Reserve Bank of New Zealand.

I’ll leave it to the reader to debate the extent of how different decision making by governments and central banks would have been with this data. In my mind, there is little doubt the changes are material and indeed would have made an impact.

It is critical that central banks and governments make decisions based on the most accurate and complete data. Regardless of whether it replaces the current approach, Reserve Banks and governments should be demanding of the ABS and StatsNZ to create an index that includes imputed rents.