This morning I have some good news to report which is the result of the around 7 year campaign I have conducted in support of the Retail Price Index or RPI. I have given regular readers a sense of deja vu with the headline and let me add to that with something I wrote for Mindful Money back on the 10th of January 2013.
I am pleased to report that today’s update will be very upbeat and will contain sections which I hoped to be able to write but felt were certainly far from favourite to take place. Regular readers will be aware that the subject of inflation is a specialist subject for me and a sub-section is the official attempts to “improve” ( in my financial lexicon such an “improvement” equals a lower number). Accordingly when the National Statistician decided to have a consultation to “improve” the UK Retail Price Index I feared the worst. However I hoped and worked for the best as I not only attended the public meeting and explained my view but responded to the consultation both in my own name and as part of the RPI CPI User Group at the Royal Statistical Society.
Those who have followed the saga will recall that last summer I noted a new review of the Retail Prices Index this time by the House of Lords Economic Affairs Committee ( EAC). I feared another establishment stitch-up so I invited the EAC to a meeting on the subject at the Royal Statistical Society to expose them to other points of view, including mine as I was one of the speakers.
In case you are wondering what this is about I will go through the technical points below but it can be summarised in the theme that the establishment invariably finds reasons to object to inflation measures which give higher numbers and favour ones with lower numbers. In terms of UK inflation that means attacking the RPI (2.7%) and proposing the measure called CPIH (2%). From the point of view of HM Treasury such a gap if compounded over time on matters such as pensions and benefits saves it a lot of money, and the gap has usually been larger than that recently. Thus whilst I have battled the Office for National Statistics, the Office for Statistics Regulation and for long periods the economic editor of the Financial Times Chris Giles the main opponent in my opinion has been HM Treasury.
What has happened here?
The official campaign was publicly pushed as being due to what has been called the “Formula Effect” which is much of the gap between RPI and the various CPI variants. I have long thought that much of the force behind the argument came from the fact that the RPI has house prices in it as well, leading to usually higher readings. But there was a way of investigating and then (hopefully) fixing this Formula Effect.
We heard evidence that the Carli formula, as used in the RPI, produces an upward bias. But expert opinion on the shortcomings of the RPI differs……. There is however broad agreement that the widening of the range of clothing for which prices were collected has produced price data which, when combined with the Carli formula, have led to a substantial increase in the annual rate of growth of RPI.
The Formula Effect has been driven by a problem in the clothing sector and particularly fashion clothing triggered by a change made in 2010. My argument all along has been let’s fix that as the Formula Effect would then be much smaller. The estimates are that the Formula Effect would be halved and maybe a bit more. We do not of course absolutely know this although there was some official research ( which was rather suspiciously abandoned) back in 2012 which gives some clues. If we get the Formula Effect more than halved then this can return to one for statistical purists rather than being at the forefront of the UK inflation debate.
given the properties of the Carli formula that may lead to upward bias have long been evident, yet expert opinion still differs, it may be a perpetual debate.
Putting it another way a major influence in this has been price collection on women’s strappy tops. The statistician Simon Briscoe was very powerful on this point.
We have to bear in mind that strappy tops are one-thirtieth of one per cent of the RPI. I can think of no other area of life or public policy where if one three-thousandth of something was wrong, we would discard the whole lot. We would simply mend it.
Those who have followed my work on this subject will know that I can only type, yes yes yes! To this next bit.
We are not convinced by the use of rental equivalence in CPIH to impute owner-occupier housing costs.
This has been a long battle against the UK establishment and for most of this period against the Financial Times as well. For example the Paul Johnson Inflation Review of 2015 supported the use of the inflation measure CPIH which uses rental equivalence or imputed rents. These do not exist in real life and are an entirely fictional concept as opposed to the house prices ( via a depreciation component) and mortgage interest-rates which not only exist but are widely understood that the RPI uses.
If it was left to me I would improve the RPI by having an explicit house price component rather than the implicit depreciation one. Maybe the EAC will get around to that.
There is much to welcome here from the EAC as if its recommendations are implemented two major problems with UK inflation measurement will be improved at worst and fixed at best.However the statistics establishment comprising the Office for National Statistics and the Office for Statistics Regulation have seen their reputation badly damaged by the frankly spiteful decision to do this and then for the latter to rubber stamp it.
given its widespread use, it is surprising that the UK Statistics Authority is treating RPI as a ‘legacy measure’. The programme of periodic methodological improvements should be resumed.
I gave evidence to the OSR and frankly I was left with the view that it is the equivalent of a chocolate teapot and should be scrapped. Just to be clear the EAC does not go that far.
Also it is welcome that other areas have come round to more like my point of view as I see that the Financial Times and Paul Johnson have been willing to look to correct past mistakes. It is never easy to do that so we should welcome it.
On the downside I see two main problems with the Review.
In future there should be one measure of general inflation that is used by the government for all purposes. This would be simpler and easier for the public to understand.
I see the point of trying to stop the government from “inflation shopping” but the truth is that we need different measures for different purposes. For example a cost of living index for wage negotiations is not the same as one for the national accounts.
The idea that we should use CPI for now and then later use a new number that includes owner occupied housing later has various problems.
The government should begin to issue CPI-linked gilts and stop issuing RPI-linked gilts. We heard evidence to suggest there was sufficient demand to make a viable market
That seems silly as we would end up with 3 types of index-linked Gilts ( RPI, CPI, and the new measure likely to be the improved RPI). Also we were supposed to put owner occupied housing in CPI back in 2003 but somehow it got “forgotten” for over a decade.
So my suggestion is to get on with improving the RPI and give the work a twelve month deadline. Then in a year’s time we could issue index-linked Gilts based on the new measure. We might be able to update some of the existing Gilts on the new basis as well but that is a matter for the Bank of England but some we would not as there were explicit rules in their documentation.
Me on The Investing Channel