New Study Reveals True Cost of Living by Including Interest Rates

A new study by the Taub Center for Social and Economic Policy in Israel highlights a significant limitation in the country's Consumer Price Index (CPI): its exclusion of interest expenses on loans and credit. Researchers Benjamin Bental and Lavi Shamai argue that this omission, particularly concerning mortgage interest, can lead to a substantial underestimation of the actual increase in the cost of living for households.

The CPI, designed to track changes in the prices of goods and services, does not incorporate the cost of borrowing money. This is a critical factor for many households, especially given that housing expenses, which include mortgage payments, constitute a large portion of the average Israeli household budget. While the CPI reflects changes in rental prices to approximate housing costs, it ignores the direct impact of fluctuating mortgage interest rates on homeowners.

The researchers developed a supplementary index that includes financing costs. Their findings indicate that this "complementary index" can be significantly more volatile than the standard CPI. Between 2008 and 2021, the complementary index generally showed lower annual changes than the CPI. However, since 2021, with rising interest rates by the Bank of Israel, the complementary index has surged. During the peak of annual inflation at 5.4% in February 2023, the complementary index indicated a nearly fivefold increase in household expenses, reaching approximately 25% annually.

Cumulatively, the gap is also substantial. While the CPI doubled the complementary index's rise between 2007 and 2021, the latter jumped by about 65% from 2007 levels in the subsequent three years. Mortgage interest payments alone increased by 42% in 2022 and 68% in 2023, according to the study. The researchers emphasize that their findings do not suggest the CPI is flawed in its purpose of measuring price changes but rather that it may not always reflect the erosion of purchasing power experienced by households, particularly when interest rates rise sharply.

The study suggests that policymakers should consider the implications of this gap. Monetary policy decisions based solely on the CPI might inadvertently increase household costs without being reflected in the index. Furthermore, for wage and benefit adjustments tied to the CPI, the exclusion of interest costs could lead to an inaccurate assessment of households' actual consumption capacity.