The Consumer Price Index is intended to reflect changes in the prices of goods and services in Israel, but in public discourse it is also often used as an indicator of changes in the cost of living. A new study by Benjamin Bental and Labib Shami of the Taub Center, a research institute that focuses on economic and social issues, points to a limitation of this use: the index does not include a significant component of household expenses—the cost of money, meaning interest on loans and credit. The researchers propose a supplementary index and show that, during certain periods, the gap between it and the Consumer Price Index may be as much as fivefold.
The largest monthly expense for the average household in Israel is housing, which accordingly accounts for about 27% of the Consumer Price Index. Around two-thirds of the housing category is allocated to “owner-occupied housing services,” in line with the share of homeowners among households. This category measures changes in the rent of properties comparable to those owned by residents, in order to reflect changes in prices in accordance with the purpose of the index. This has been the practice in Israel since 1999, as it is in many other countries.
By contrast, interest on mortgage repayments, which may have a significant impact on household expenses, is not included in the index.
Therefore, an annual change of 1.5% in the Consumer Price Index may not reflect the actual burden on household expenses. Studies have found that when the Consumer Price Index in the United States stood at 6%, actual expenses rose by an average of 18% due to financing costs that were not included in the index. Including financing costs accounted for 75% of the gap found between the change in the index and consumers’ perceptions of changes in their expenses.
Supplementary Index Surged to Around 25% at the Height of Interest Rate Hikes
The “supplementary index” developed by Bental and Shami examines the impact of changes in financing costs on household expenses and compares them with the Consumer Price Index. A comparison between 2007 and 2024 found that the supplementary index is more volatile than the original index, and is not necessarily higher or lower than it.
In fact, between 2008 and 2021, the annual change in total costs, taking into account the cost of money, was lower than the Consumer Price Index for most of the period.
However, from 2021, as developed countries emerged from the period of low interest rates and the Bank of Israel raised its interest rate to 4.75%, the supplementary index surged at a rate far higher than the Consumer Price Index. While annual inflation peaked at 5.4% in February 2023, the supplementary index pointed to an annual change of about 25%. This gap means that the actual increase in expenses was almost five times higher than that reflected in the Consumer Price Index.
The gap is also evident when examining the cumulative increase over the period. Between 2007 and 2021, the Consumer Price Index rose by twice as much as the supplementary index, but over the following three years, the supplementary index surged from an increase of around 10% to an increase of around 65% compared with 2007.
Bental and Shami show that mortgage interest payments increased by 42% in 2022 and by 68% in 2023. Housing expenses for homeowners are also affected by other factors, such as changes in housing prices, but according to the study, their impact is small compared with changes in interest rates.
The Index Is Not Flawed, but Does Not Always Reflect the Erosion of Purchasing Power
The study emphasizes that the gaps identified are important for understanding the actual costs for households, but they do not point to a flaw in the Consumer Price Index, whose purpose is to examine changes in the prices of goods and services.
In 1983, housing costs and mortgage prices were removed from the index in the United States in order to stabilize it and avoid the volatility of the real estate and credit markets. A similar move was made in Israel.
The study does not include recommendations for immediate implementation, but suggests taking the implications of the gap into account. Monetary policy based on changes in inflation may lead to an increase in household costs that is not reflected in the index.
In addition, in cases involving the indexation of wages, benefits, and long-term agreements, using the Consumer Price Index may not reflect the erosion in households’ purchasing power, and the researchers say this should be taken into account.