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Article, 29 June 2005 14:15

# Consumer price index

Statistics Netherlands publishes monthly information on the consumer price index (CPI). Here, we describe briefly what consumer price indices are, how they are compiled, which CPI series are calculated and how they can be used in practice. Examples are given of how to use the indices to adjust prices in contracts

## The consumer price index (CPI)

What is the CPI?
Every month Statistics Netherlands calculates and publishes the consumer price index (CPI). The CPI reflects developments in the prices of goods and services which consumers buy. It is an important measure for inflation and is used on a wide scale by the government and in trade and industry, among other things in wage negotiations, for the indexation of rents and annuities and to adjust tax tables. Inflation is measured as the percentage of increase of the CPI in a certain period compared with the corresponding period in the previous year.

Which goods and services does the CPI refer to?
The CPI reflects increases and decreases of the prices of goods and services which an average household in the Netherlands bought in the base year for the purposes of consumption. This package of goods and services is also known as the basket or shopping basket. The basket contains day to day shopping items, spending on durable consumer goods such as washing machines and cars, rent, school and tuition fees and consumption-related taxes such as property tax and motor vehicle tax. Not all expenditure is included in the calculation of the CPI: income tax, social premiums and spending on insured health care, for example, are nor taken into account.

If a certain article changes, or if it is no longer available in the shops, the price of a similar article is observed. As this replacement will often be of a different quality, the CPI is corrected for the differences. In this way only the pure increase in price is measured.

## Base shift

Base year The CPI reflects the price level of a basket of goods compared with the average price in a given year, the so-called base year. From 2003 this base year will be 2000. Household spending patterns may change in the course of the years, for example because new products are introduced and because of changes in the composition of the population. Changes in prosperity levels, too, influence shopping behaviour. Therefore, Statistics Netherlands regularly adjusts the package of goods and services it measures: when the CPI basket no longer accurately reflects spending by consumers, Statistics Netherlands chooses a more recent base year. This is called a base shift. Normally the base year for the CPI shifts once every five years. However, in order to incorporate changes in consumption patterns more quickly Statistics Netherlands plans to adjust the base once a year. This will constitute a major quality improvement for the CPI.

### Table 1. Expenditure by households in 2000

 % Total consumption expenditure 100.0 Food and non-alcoholic drinks 11.1 Alcoholic drinks and tobacco 3.1 Clothing and footwear 6.4 Housing, water and energy 21.8 Furnishings, household appliances and day-to-day home maintenance 7.1 Health 0.6 Transport 12.1 Communications 3.6 Recreation and cultural activities 11.5 Education 0.1 Hotels, restaurants, cafés, bars, pubs 4.4 Miscellaneous goods and services 10.2 Consumption-related taxes and government services 3.4 Consumption abroad 4.6

## The derived consumer price index

The derived CPI is the same as the regular CPI, but excluding the effects of changes in the rates of product-related taxes (e.g. VAT and excise on alcohol and tobacco) and subsidies. The derived CPI answers the question of how prices would have developed if tax rates were the same as in the base year. The derived indices are used to correct wage and income tax levies, and also often in wage negotiations.

## The harmonised consumer price index (HICP)

The harmonised consumer price index (HICP) has been specially developed as a comparable measure of inflation for all member states of the European Union (EU). Eurostat, the Statistical Office of the European Union, uses the HICPs of the member states to calculate inflation in the Eurozone and in the European Union. The existing national indices are unsuitable for this purpose as the national calculation methods differ too much.

The main difference between the Dutch index (CPI) and the HICP is the composition of the package of goods on which the HICP is based. Living in an owner-occupied dwelling (rental value), consumption-related taxes (property tax, motor vehicle tax, etc.) and subscription and membership fees for sports clubs, social clubs etc, for example are included in the CPI but not in the HICP. On the other hand, the HICP does include more costs paid for health care than the CPI. Another difference between the two indices is that the CPI includes price increases in private consumption by Dutch people abroad, while the harmonised index includes the private consumption by foreigners in the Netherlands.
Both the CPI and the HICP are based on the spending pattern of households in 2000. The internationally agreed reference year for the HICP is 1996.

## Collecting price information

Every month 250 interviewers from Statistics Netherlands visit various shops throughout the country and record 80,000 prices of more than 1,600 different items. For items with strongly fluctuating prices, for example fresh fruit and vegetables, Statistics Netherlands even collects prices three times a month. The change in the level of house rent, an important component of the CPI, on the other hand is measured only once a year. Not all prices are recorded by interviewers in the field. Some are measured by way of written and telephone surveys, and information is also increasingly collected via the Internet. To measure supermarket price developments, scanner data are used more and more often. These contain information on numbers of products sold and turnover for all items in the supermarket, which is used to calculate average prices. This has resulted in a quality improvement for the CPI, as scanner data make it possible to monitor more products than interviewers could in the past.

Publication programme for consumer price indices

From January 2003 onwards, Statistics Netherlands will publish the following series of price indices:

Monthly

• CPI for all households + derived series
The series for all households is based on the spending pattern of an average Dutch household.
• Harmonised consumer price index (HICP)
This index is intended for the international comparison of inflation rates.

Yearly in January

• CPI for employee households + derived series
The CPI for employee households shows the price developments for an employee household, regardless of its level of income.

## Using the CPI in practice

Price increases (or decreases) usually lead to regular adjustments in rent, social benefits and other allowances. Statistics Netherlands' consumer price index is used in many business and private contracts to adjust them accordingly.

Which index?
In general, for tenancy agreements Statistics Netherlands advises partners to use the CPI for all households for new agreements or the revision of existing ones. Contracts drawn up in the past sometimes refer to indices that are no longer calculated. In such cases the present CPI for all households can be linked to the old series. These linked series are available from Statistics Netherlands on request.

Which base year?
Some contracts refer to an "old" base year, for example 1990=100. Indices are no longer calculated on the basis of the consumption pattern of that year. In such cases it is advisable to use figures referring to the most recent base.

In some cases, though, indices with an "old" base year are required. For example, tenancy agreements in which the originally agreed rent (initial rent) is used as a starting point for rental adjustment. The level of such initial rent was often agreed decades beforehand. In this case the adjustment can be calculated with the aid of the so-called fixed denominator method (see below). However, this method does require current indices with a more recent base year to be recalculated to a previous base year. This recalculation consists in linking the figures with the old reference year to those with a more recent reference year. These linked figures are available from Statistics Netherlands on request.

Both annual and monthly figures are used for rent adjustments. The monthly figures relate to the middle of the month; the annual figures (also called the index figures for the calendar year) are the arithmetic average of the monthly price indices in a certain year. The indexation clauses of tenancy agreements usually specify which index figures are to be used. The contracts also specify which method should be used to index rent levels. The most widely used methods are the year-on-year method and the fixed denominator method.

The year-on-year method
In this method the current rent is multiplied by a fraction (rounded to 3 decimal places) which is calculated by comparing two indices one year apart.

Example:
The rent for a building in 1999 is € 3,000 per month. The CPI for all households is used for the adjustment.

The CPI for all households for:  1998=106.3

1999=108.6

2000=111.4

2001=116.4

Rent in '00: 108.6/106.3 = 1.022 * € 3,000.00 = € 3,066.00
Rent in '01: 111.4/108.6 = 1.026 * € 3,066.00 = € 3,145.72
Rent in '02: 116.4/111.4 = 1.045 * € 3,145.72 = € 3,287.27

Fixed denominator method
This method starts out from the originally agreed rent. This rent is multiplied by a fraction in which the numerator changes form year to year while the denominator remains the same.

Example:
The rent of a building is € 1,400, applicable from 1 January 1999. Under the agreement the rent is to be adjusted for the first time on 1 July 1999 and subsequently annually. The CPI for all households is used for the adjustment.

The CPI for all households for:  September  1998=107.0

March 1999=108.5

March 2000=110.6

March 2001=115.7

On 1-7-'99 the rent will be: 108.5/107.0 = 1.014 * € 1,400.00 = € 1,419.60
On 1-7-'00 the rent will be: 110.6/107.0 = 1.034 * € 1,400.00 = € 1,447.60
On 1-7-'01 the rent will be: 115.7/107.0 = 1.081 * € 1,400.00 = € 1,513.40

This method often requires index figures with an "old" base year. These are available from Statistics Netherlands.