The Implications of Recent Changes to the Consumer Price Index for Monetary Policy and the Inflation Target

Since 1993, the conduct of monetary policy in Australia has been based on an inflation target. Under this framework, the aim of policy is for underlying inflation to average 2 to 3 per cent per annum in the medium term. Underlying inflation can be measured in a number of ways but each of these measures shows that the target has been achieved so far in the 1990s (see Table 1). The concept of underlying inflation has been used in order to avoid distortions associated with the most common measure of inflation – the Consumer Price Index (CPI). The main distortion in the CPI as measured in the past was in its treatment of mortgage and consumer interest rates, which made it an unsuitable reference measure for monetary policy. Recently announced changes to the CPI, however, particularly the different treatment of housing costs, will reduce substantially the problems in using the CPI to evaluate monetary policy, particularly if the evaluation is over a period of time rather than quarter to quarter. While short-term volatility in the CPI will remain an irritant, as with all economic statistics, the Bank’s view is that the inflation