Yesterday in some respects was a milestone for the UK as the Office for Budget Responsibility published its first set of forecasts. I have some more thoughts and analysis of this subject below. However internationally there was some news as Moody’s downgraded Greece’s financial rating by four notches from A3 to Ba1. I had two initial thoughts.Why now? followed quickly by do try to keep up with current events ratings agencies. However I then remembered that the IMF has an assessment team in Greece this week so Moody’s are most likely afraid of what it might uncover. Also Spanish debt markets were under pressure again yesterday a subject which will not go away. I will return to these subjects again but after a further review of the OBR today is the day for the UK’s inflation indices.
Further analysis of the Office for Budget Responsibility’s Report
After looking at its report again I thought that in many peoples minds one question would come up.
How did the OBR reduce growth forecasts and simultaneously reduce the deficit?
At first sight this appears to be outright financial alchemy as reducing growth would raise estimates of the deficit all other things remaining the same, however it is more complicated than that.As well as the reduction in estimates of future economic growth the OBR made some other assumptions which went in the opposite direction. These were.
1.The OBR forecasts assume that the share of VAT revenues that the Government will collect will remain constant over time as opposed to decreasing, as Chancellor Darling had cautiously assumed . In other words VAT tax evasion will not increase.
2.The OBR believes that public spending in 2010–11 will be £4.1 billion lower than forecast in the March 2010 Budget and it has carried this under-spend forward into future years which reduces public spending going forwards. and hence the forecast deficit
3.The OBR expects stronger underlying tax revenues over the next few years of an amount , sufficient to reduce forecast borrowing by up to 0.7% of GDP. So it is anticipating the continuation of a trend which was evident in recent figures which helped lead to a smaller budget deficit in 2009–10 than Mr Darling forecast in his March 2010 Budget.
4. The OBR’s forecasts are central estimates rather than supposedly ‘cautious’ ones. In other words in spite of the optimistic growth forecasts it would appear that civil servants used various ruses to influence the numbers (for example future assumptions about unemployment and hence benefit payments and taxes).
There has been I think a benefit from this process as I explained yesterday. My main concern is that with all the changes I have highlighted today and yesterday a rather similar set of numbers have appeared. One might wonder as they are so similar as to what the point was.
In addition please remember when you read such forecasts and constructs that there are only a guide and the guide is only as good as the assumptions used in it. The old computer phrase “garbage in garbage out” definitely applies. These are a framework for consideration and perhaps the best we can do now. On average they will be wrong rather than right.
It would appear that ex Chancellor Darling produced a more cautious set of figures than might reasonably have been suspected from his growth forecasts. This establishes two things I think. One is that the accusations levied at him by the new government look unfounded as his numbers have stood up to scrutiny overall. The second is that he may well have been a better Chancellor than he has been given credit for as it would appear that he resisted his neighbour more than was realised at the time. I am aware that many will think that there is a certain irony in the manipulation of numbers and forecasts being used to thwart Gordon Brown.
Inflation in the UK
There has been a discussion on this site recently about money and wealth and some on types of inflation measure so today I shall review some previous discussion on this subject as I type awaiting todays inflation numbers. I still believe that the one taught in the economics text books I read at university ” a continuous increase in the general price level ” is the best measure of inflation although it is far from perfect. But it is reasonably measurable and does give a guide to the situation.
If we start from the beginning to measure inflation defined in this way you have to check the prices of a basket of goods over time and once you have done so you have a measure of inflation. So there is already there are 2 issues,firstly unless you check every price your measure will be imperfect and secondly if you change what you measure there will always be debate over what is included and excluded. In the modern era you can add hedonics to this where the authorities adjust the index to allow for quality improvements such as the way technology has improved although there is a lot of debate as to how this has worked in practice ( please see my comments section from last weekend for some views on this).
Also underlying the whole thing is the concept of a price. Again this seems simple. However just looking at my own supermarket basket I have been following a few items over the last year or so. For example own brand wine gums have varied between 27 pence and 85 pence. Recently a 300 gram tin of garden peas cost 14 pence whilst a 142 gram tin cost 26 pence. So what is the price of these two articles and what level of inflation would we get from them? It is not easy is it? Another example has been my favourite brand of tea (English Breakfast Tea), the price of this has varied considerably, one hundred tea bags were £3.92, then on an offer 50 of them were £1.50 and now 100 tea bags are £3.10. So what is the price? I like salmon but salmon fillets have gone from £8.50 per kilo to £11. I also like bags of mixed nuts where a 250 gram bag recently went from 85 pence to £1.20. As the world has changed as a nation we shop more at supermarkets. Everybody who does so will realise that they manipulate prices quite a lot. My contention is that it is hard to know the price of even something that you buy regularly and if you cannot determine the price you have no chance with calculating an inflation rate.
Another issue is that products change in terms of quality (usually for the better). For examples cars have tended to have higher specifications. To put this in concrete terms I remember paying 10 years ago an extra £750 for my car to have air conditioning. Now most cars have it as standard. Car prices have risen but the value of air conditioning is no longer £750 so what value should we use? It gets even harder in the case of something like an mp3 player that did not even exist to be in older cars! So how much of the increase in the price of a car is inflation? Those who try to measure inflation try to allow for this but it is not easy to do so.
When I started this blog one of my first articles back on the 17th November 2009 was on this subject and I still agree today with my conclusion (and am pleased to see I was rather prescient!).
So I hope that when you look at todays inflation numbers you take them with a pinch of salt and look at general trends rather than monthly figures. To my mind inflation in the UK as measured by the Consumer Price Index has proved to be quite persistent through a period when many were telling us it would be heavily negative and there are considerable implications for the future from this.
Today’s figures for inflation
These continue the disappointing trend of UK inflation figures. According to the Office for National Statistics Consumer Price Inflation is now 3.4% which whilst down on last month’s 3.7% is still higher than many thought we would get at any point this year and continues a trend of inflation being more than 1% over its target. On a month on month basis it rose by 0.2%. Ordinary RPI is now 5.1% and has dipped back from last months 5.3%. RPI-X (our old targeted measure) is now 5.1% having dipped back from last months 5.4%.
What has caused this?
This months slight slowdown in inflation has several factors behind it. The decline in CPI and RPI was driven by a fall in food prices on the month (particularly those of grapes and pork products) as well as slower rises in the price of petrol, alcohol and tobacco than the same month last year. The RPI figures were also affected by a rise in their housing component as housing costs, which have a higher weight in RPI than in CPI rose by 3.5 percent, their fastest pace since May 2008. This meant that the RPI figures as measured on an annual basis fell back by less than the CPI figures.
There are two ways of looking at these numbers. The first is to look at the fact that they have dipped back from last month which is welcome for the UK economy. However returning to my theme back from the 17th November last year one should also look at the general trend of the numbers and this has been poor throughout this year. Even todays lower numbers would have come as a shock to most observers if you have told them back in January as they are still 1.4% over the official target.
If you look at our previous target then the picture deteriorates further. The old targeted measure of RPI-X now at 5.1% had a target of 2.5% so it is 2.6% over its targeted level. I am one of those who feels that the change in target was a retrograde step basically for the reason highlighted above, the new measure in general tends to give lower numbers and exceeds its target by less. That is not the way in my view to inspire confidence in your inflation statistics.
Going forwards over the summer I expect CPI inflation to drift back to 3% and I hope that it does so. However the question for the Monetary Policy Committee is based on 3.5%,3.0%,3.4%,3.7% and now 3.4%, these are the figures for CPI inflation so far this year and the question is from David Byrne of Talking Heads who in one of his songs opined “how did I get here?”