Why use real numbers to measure inflation when you can make them up?

Today brings us yet more evidence on the rise of consumer inflation in the UK. Regular readers will recall that I warned earlier in the year and indeed pre the EU leave vote that a pick-up in inflation was on the cards. Back then much of this view was simply based on the likelihood that the crude oil price would stop falling and the disinflationary effect from it would fade and then end. Then we would see some of the institutionalised inflation of the UK come into play. An example of this has been inflation in services which has rumbled on at about 2% per annum and thus pretty much ignoring the phase of good price disinflation we have just experienced.

Crude Oil

This was in the high 30s if we look at the US Dollar price for Brent crude oil at this time last year and was about to fall so that it fell below the US $30 mark in early January. This compares to a price of just below US $56 so even allowing for daily fluctuations we are on a higher trajectory now and seem set to remain so. Even a rush of production from the shale sector seems unlikely to get us back below US $30 anytime soon. So we see that rather than disinflation we are now seeing some inflationary pressure from the oil price.

The UK Pound £

In spite of the recent rally it has been a poor battered UK Pound for most of 2016. It was in fact falling before the EU leave vote but then it fell sharply creating inflationary pressure via higher prices for imports. This is not something which happens in full immediately as it takes time for fixed-price contracts for example to be replaced with new and higher terms but it is in progress.

If we look at the numbers then this time last year the UK Pound was about to dip below US $1.50 whereas it is now just below US $1.27. Thus we see that commodities prices including the oil one above have around a 15% nudge higher from the exchange rate. Ouch! Other prices will have risen too as the UK Pound has fallen albeit mostly less against many other currencies as well. Even the currency against which it feels there has been a strong bounce back the Japanese Yen is only back to 146 Yen.

Bank of England

We do not get reminded often these days of the latter effect of this statement about QE or Quantitative Easing.

This process aims to directly increase private sector spending in the economy and return inflation to target.

So they are pushing inflation higher just as it was about to surge anyway. A clear policy error and yet another Forward Guidance failure.

Today’s numbers

We saw this.

The all items CPI annual rate is 1.2%, up from 0.9% in October

I pointed out last month that the dip in the numbers was something of a statistical fluke although the media and analysts either forgot or did not notice that by the mentions of an “unexpected” rise. Anyway here is a reminder of the continuing shambles which is the efforts of the Office of National Statistics to measure UK clothing inflation.

This is the largest October to November rise since 2010 and continues the rather volatile movements observed during 2016, especially over the latest 3 months.

This is a fundamental issue which I posted on the Royal Statistical Society website about a month ago highlighting the situation about ladies coats which I am told lack any lining this year and are therefore cold. I have opened a can of worms I think

http://www.statsusernet.org.uk/communities/community-home/digestviewer/viewthread?MessageKey=be4841f9-ef68-4d1b-80a9-7d859cf6b53c&CommunityKey=3fb113ec-7c7f-424c-aad9-ae72f0a40f65&tab=digestviewer#bmbe4841f9-ef68-4d1b-80a9-7d859cf6b53c

If we move back to today’s news then we are seeing in the November figures the effect of the weaker UK Pound in essence. Also there is a significant change as it may only be 0.2% but the trend is clear.

The CPI all goods index annual rate is 0.2%, up from -0.4% last month.

Coming over the horizon

The producer prices situation is beginning to have its effect.

Factory gate prices (output prices) for goods produced by UK manufacturers rose 2.3% in the year to November 2016, compared with an increase of 2.1% in the year to October 2016.

We see that in the goods prices I discussed above and further down the line we see more ch-ch-changes.

The overall price of materials and fuels bought by UK manufacturers for processing (total input prices) rose 12.9% in the year to November 2016, compared with a rise of 12.4% in the year to October 2016.

Housing Costs

I would like to demonstrate today why the planned change in the main UK inflation measure will leave us with the equivalent of a chocolate teapot. The UK National Statistician put out his thoughts late last week and I replied confining myself to a sentence plus one word.

Dear Danny

Thank you for posting the letter from John Pullinger to Tony Cox. There is much I would like to reply on but we learn so much from one sentence which I have copied below.

 

“Our view is that neither mortgage payments nor house prices are a good measure of housing costs. ”

 

So the largest payment someone ever makes in regards a house and/or the largest stream of payments are both to be ignored! They are then replaced by a number under the banner of Rental Equivalence which by contrast is neither paid nor received and in fact is imputed.

The banking sector got itself into quite a mess by replacing mark to market accountancy with mark to model or as some called the latter myth. It has still to recover from this “advantage”.

As this news filters through to the public, confidence in official statistics will be reduced rather than enhanced. This will not be helped by the timing of this as inflation moves above the Bank of England’s target next year.

As of March we will use what is called CPIH as our main inflation measure where H supposedly measures housing costs. Except you see for owner-occupiers it does not and instead with its made up number sings along with Earth Wind & Fire.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

My message has got a decent response already and this one from Arthur Barnett hits home.

Shaun,

You have picked up on an interesting sentence from the National Statistician’s letter.

I would add another sentence –

 

“It is for the above reasoning we believe that the treatment of housing costs in RPIJ is weak.”

 

The two sentences refer to views and beliefs rather than evidence – indeed the National Statistician’s letter does not appear to include the word evidence.

If we switch to the numbers we see that house prices are rising at an annual rate of 6.9% whilst CPIH does this.

The all items CPIH annual rate is 1.4%, up from 1.2% in October

Comment

So we are now on course to hit the UK’s inflation target and maybe quite quickly. One way this may be achieved will be from the price of petrol at the pumps. We have been told today that it is some 10 pence higher than a year ago which adds some 0.3% to consumer inflation all other things being equal. This is not something that I welcome although economists such as my debating partner on Radio 4’s Moneybox Tony Yates presumably does although it is still a long way short of the 4% inflation target he has argued for. Still anyway here is a link from 3 months ago to it when I was pointing out that the Bank of England had made an inflationary policy error.

Also the numbers looked like they were leaked again and I do not necessarily mean the way those in authority get them 24 hours before. Traders in the UK Pound £ seemed to have an Early Wire yet again.

Meanwhile RPI inflation rises at 2.2% or if you exclude mortgage interest payments RPIX is at 2.5%. I remind you of this because our official statisticians have spent the last 3/4 years trying to rubbish it. Yet even the Bank of England has to admit this.

Asked to give the current rate of inflation, respondents gave a median answer of 2.3%, compared to 1.8% in August.

Apparently everyone is wrong again.

 

 

 

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15 thoughts on “Why use real numbers to measure inflation when you can make them up?

  1. Shaun,
    Increase in Insurance Premium Tax, rail fares etc now built in for 2017 inflation plus possible council tax rise to cover social care costs adding to housing expenditure.
    About time NI contributions ringed fenced for health/ care expenditure only so we know what we are paying for?

    • Hi Chris

      The catch is that the establishment has been content to let those who do not follow the finance situation particularly believe that NI contributions pay for the NHS and state pensions. So a type of confession would be required.

      As to Council Tax I note that it may rise by 6% in some places and sort of along the lines you suggest. From SkyNews.

      “Local authorities will be allowed to raise council tax bills by 6% to help raise cash for social care “

  2. Great blog, Shaun, exposing the contradictions in the system. I would only add that:
    1. It seems to me that a precise figure will always be bogus, as it also assumes a standard basket which will vary between people and across the country;
    2. Very small movements one way or another should probably be taken with a pinch of salt;
    3. I don’ think that the BoE is interested in the facts. It is interested in puffing out its chest with pride at having saved the country through QE.

    • You are right. The misconception is that there can be a single representative figure for inflation. Since housing is such a major portion of expenditure then there might be a more accurate inflation figure that could be calculated for each category of occupier – renting, mortgaged, absolute owner. Since the numbers of these in each category can be estimated it would be more meaningful, they then could then be combined to produce a more accurate but still relatively meaningless overall inflation figure if desired. Always provided that all four are published.

      • Peter, I don’t agree with you at all that inflation measures are meaningless. However, you are right that the divisions of households by tenure: tenant, homeowner with mortgage, homeowner without mortgage are demonstrably more important than the divisions between households by income status that more often fire the imaginations of people looking for special CPIs.

  3. Are the ONS fiddling the inflation figures by omission or commission?

    I’m not a conspiracy theorist but one does have to wonder. These inflation numbers are used in some form to uprate large parts of government spending and 0.1% per annum doesn’t seem much but the magic of compounding means that over ten years, say, you are talking about real money. Is this delay and, indeed fiasco, re housing anything to do with the fact that housing costs have risen quite sharply in the last few years? Could we get a much more sensible system as the market stalls and the effect on the inflation rate gets smaller when a housing adjustment is finally built in?

    Another and more fundamental point is the ratchet effect. If we had a sustained period of true deflation would benefits and pensions really be reduced? With regard to housing in particular this tends to be cyclical (periods of strong growth followed by gradual decline – see late 1980s to mid 1990s). A housing adjustment might cause the index to grow quite sharply in strong growth periods but only decline slowly in the “bust” period. The decline period in the mid 1990s was a real terms decline in a period of strong inflation; if now we had a decline with low inflation and therefore a much greater decline in nominal prices would the effect on the index be “acceptable”? Putting it another way you could have strong inflation of the cost of living offset by negative housing costs which people might have difficulty in accepting (my supermarket bill has gone up by 10% and yet I’m told the inflation rate is only 2%! – Daily Mail).

    These people may be smarter than you think.

    • Hi Bob J

      Your last sentence is against the available evidence but perhaps there is a deeper plan! As to the numbers there are always issues in any inflation index except for the person or persons who are average or more likely median. Actually the current system is biased above that.

      Whilst there are issues when housing inflation goes the other way from other types of it that is also true of other components at times as we have seen recently with goods inflation and services inflation.

    • Hi JW

      I have been fascinated by the replies to my enquiry about ladies coats. In a nutshell we have another word for me financial lexicon for these times which is “quality”. We are told it is measured and allowed for but to the question how? We get the answer that it is not always.

      Of course measuring ladies fashion has all sorts of issues but an effort should be made.

  4. Govt. policy: get as much inflation into the system as possible, whilst simultaneously counting as little as possible.
    It’s not the shambolic mess it appears; it’s a very clear, calculated agenda to make the bottom 99% worse off, and the lower in the 99% you are, the harder you are to be hit.

  5. They think they can tell ‘white lies’ with impunity, but fail to see the costs to their credibility until it is too late.

    I don’t believe there will be any recovery until the voters get a credible and honest political option.

  6. Great blog as always, Shaun.
    Thank you very much for highlighting the letter from the National Statistician to our RPI CPI User Group. The rental equivalence approach to owner-occupied housing (OOH) has always been closely linked to the opportunity cost variant of the user cost approach. Prior to the US switching to the rental equivalence approach to OOH in the CPI-U in 1983 it published a study:
    http://www.bls.gov/opub/mlr/1982/06/art2full.pdf
    that justified the change by arguing that the opportunity cost for a tenant of occupying the dwelling would be greater than or equal to the imputed rent on the dwelling; that user cost would relate to mortgage interest payments, since that is what we are talking about, not full mortgage payments. So if Pullinger doesn’t like mortgage payments in an index because they “mix up how houses are financed with the price of housing” he doesn’t get away from them, at least in principle, by resorting to imputed rents.
    Today, Tanya Flower of the ONS has published the new OOH(Payments) series along with the update of the OOH(NA) series. Where John Astin and Jill Leyland envisioned an OOH series for their household inflation index (HII) with a broadly based payments approach, including net equity payments, this payments index is a narrowly defined series along the lines of what was in the RPI before 1995. Presumably this is what is planned for the Index of Household Payments, not, revealingly, an HII, to be published at the end of 2017, as an annual, not a monthly index.
    Anyone who had any illusions about an HII being generated from scratch that would be a super improved version of the RPI/RPIJ must by now have been disabused of that notion. Everyone should rally around the RPI/RPIJ to continue funding of improvements in both series, to continue publishing the RPIJ after its January 2017 update, and to start publishing the RPIJ in its full commodity detail. For now, until the issue of the gilts is settled, there is no real need to choose between the RPI and the RPIJ. It would be wasteful to calculate two indices forever but for now people who otherwise have common cause in opposing the imposition of the CPIH as an index for upratings should not allow themselves to be divided because they have different views on the formula effect.
    The annual CPIH inflation rate was 1.0% in 2016Q3 up from 0.7% the previous quarter. This compares with an RPIJ inflation rate of 1.1% in 2016Q3, up from 0.8% in the previous quarter. The difference may seem like small beer, but remember that the RPIJ estimates don’t include stamp duty as they should, and the just released OOH(Payments) shows that stamp duty was up by 4.4% in 2016Q3, as opposed to 4.0% in 2016Q2. Also the differences have been much larger in the past. In 2009Q2 the annual RPIJ inflation rate was -1.6% as opposed to 2.1% for the CPIH. An index that would show such a high inflation rate when house prices were in free fall just isn’t credible.

    • Hi Andrew and thanks.

      Those like yourself who were fans of the new RPIJ measure have been badly treated. I will make a note of your point about inflation in 2009Q2 as I think it is a very good one. We should have been seeing disinflation at the height of the credit crunch impact.

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