It is time to replace consumer inflation measures with inflation faced by us

Let me open today by agreeing with the Bank of England. As many of you are aware I wrote to Governor Carney challenging the testimony he gave to the House of Lords on the 30th of January. Here is part of the response from the Bank.

No measure of consumer prices is perfect.

A good start however sadly they then claim to agree with me whilst putting  a word in my mouth so to speak that I did not say. I have highlighted it below. Also as CPI has been used as their inflation target since 2003 one might wonder where this point of view has been the last 15 years.

We agree that the single biggest shortcoming of the current CPI is that it excludes the consumption price of owner-occupied housing.

If you could sum up what is wrong with the UK establishment view on inflation that single word does it. By putting it like that you go from an owner occupier spending quite a bit of their income over time on their home to someone who spends far less as it is put into another category as it is an asset which doesn’t count and/or an investment which doesn’t count either. Fantastic isn’t it? Chelsea fans like me would have loved to have done that to Barcelona;s goals last Wednesday night but even the murky world of football does not stoop so low.

On the consumption road the owner-occupier does this.

As you will know, measuring this is not straightforward because the consumption cost of owner-occupied housing services is not directly observable. As you note, people do not pay rent to themselves to live in their own home.

Of course it is not directly observable as it is a fantasy number which is imputed as it does not exist. Theory over reality again, what could go wrong?

This is considered an economically sound concept and it is easy to understand, the price a homeowner would have to pay to rent a home similar to their own, but it is clearly an imputed one.

Is “economically sound” an oxymoron? Also it may just be where I live but I have little idea of what they rental value of my flat is and as I live there am not much bothered. As to the idea that it is easy to understand may be so in the Ivory Towers of the Bank of England but I bet if you asked people you would get the reply “but I don’t”. If we go deeper there has been a lot of trouble with measuring this as the Office for National Statistics does not get the source data and is on its second effort in terms of overall series. Those of you willing to look back to 2012 on here will note that I warned about problems with the original series back then but the establishment of course knew better and when it failed it was as usual nobody’s fault. I have seen arguments that its failure to properly stratify between new and old rents means that it is perhaps 1% per annum to low. If we now move to today’s data release you can see the significance of this.

Private rental prices paid by tenants in Great Britain rose by 1.1% in the 12 months to February 2018; unchanged from January 2018.


If we move to the Retail Prices Index or RPI the Bank of England tells us this.

RPI suffers from this problem.

Which is?

In any event, an important factor in any measure of consumer prices is avoiding the influence of movements in asset price valuations (such as land prices and asset valuations of housing structures)…………. Indeed, by the inclusion of mortgage interest payments, RPI conflates the consumption cost of housing not only with asset valuations, but also with the costs of financing the acquisition of those assets.

Again theory trumps reality as something which is a large part of people’s budgets disappears from the inflation data as reality gets twisted in the clouds inhabited by the Ivory Towers. Indeed when someone is really dismissing you they tell you are important but….

We should stress that none of this is to say that house prices and mortgage interest payments do not matter. Accurate information on these is central to much of the work of the Bank’s Monetary Policy and Financial Policy Committees as well as many other economic and financial policymakers.  They matter a great deal,

They matter so much that they need to be excluded. If we look at other perspectives this matters I note some work by the NIESR suggesting that 62% of households are owner-occupiers and that this has happened.

There is a genuine question of affordability with housing.,,,,,Essentially since 1997, house prices have become twice as expensive relative to incomes.

That is the real reason that house prices are kept out of the inflation data as you see then the rises are increases in wealth and filter their way into economic growth.Maybe some is but a lot of this is inflation as first-time buyers will not noting ruefully.

Let me put this another way by noting this from the Bank of England.

As you suggest, the other main alternative is the net acquisitions approach.

No I said house prices as  my support for the net acquisitions approach has faded and let me explain why with two numbers. The weight of owner occupiers in CPIH is 17.4% but the weight using net acquisitions is 6.8%. Just as a reminder it is the same housing stock. But even with that manipulation there is a clear difference.

Owner occupiers’ housing costs (OOH) in the UK under the rental equivalence approach have grown by 1.5% in Quarter 4 (Oct to Dec) 2017 compared with the corresponding quarter of the previous year.

OOH according to the net acquisitions approach have grown by 2.9% in Quarter 4 2017 compared with the corresponding quarter of the previous year.

This comes from a release which in my opinion was part of a propaganda campaign to convince us that all roads led to the same answer. As you can see that is misfiring and perhaps like the effort with the RPIJ measure will find its way into the recycling bin both friendless and abandoned.


If we look at today’s data the news is better as we see a fall in consumer inflation with the CPI measure falling to an annual rate of 2.7% and RPI to 3.6%. Those of you mulling the potential for a second Battle of the Thames today as well as those who like to keep up to date on the price of fish might like to know that fish prices rose by 1.3% this February as opposed to 4.7% last year. Looking deeper into the inflation chain we see this.

The headline rate of inflation for goods leaving the factory gate (output prices) was 2.6% on the year to February 2018, down from 2.8% in January 2018. Prices for materials and fuels (input prices) rose 3.4% on the year to February 2018, down from 4.5% in January 2018.

The media report this as the fall in the Pound £ dropping out of the numbers actually especially in the input series it is the stronger £ versus the US Dollar at play as it has a pretty direct line in. It will impact on the other measures as 2018 develops and help to bring down their numbers

Returning to my theme we end up with a pretty clear conclusion as to the establishment’s game as RPI at 3.6% is rubbished and CPI at 2.5% is promoted. I wrote some time back that they always promote things which give the lowest number and if I am ever wrong fell free to let me know. Meanwhile my arguments are hitting home as I notice some of my opponents are getting cold feet.

It has only taken 6 years. If we move onto planning ahead I think we have to move from consumer inflation to the inflation people experience as otherwise we miss this as explained by Edward Harrison.

Using the Minsky model, it’s wholly possible that asset price inflation is through the roof even while consumer price inflation barely budges. For example, say you have a credit crisis that throws people out of work and causes mass unemployment. In that case, it would take many years to get back to full employment. You won’t see inflation rising robustly. Yet, during that period, the central bank could set interest rates at a level that encourages an increase in speculative and then, eventually, Ponzi financing. That’s a recipe for asset price inflation without consumer price inflation.

Whatever your views on the Minsky model that bit is pretty much impossible to argue with. Now should we go forwards with that or backwards with “economically sound concepts” which keep failing?


Euro area monetary policy heads for a new frontier

The issue of monetary policy in the Euro area is of significance on several levels. Obviously it affects the Euro area itself but also it affects many countries around it as in a nod to the sad departure of Stephen Hawking overnight it is time to sing along with Muse.

Into the supermassive
Supermassive black hole
Supermassive black hole
Supermassive black hole
Supermassive black hole

This has been demonstrated by the way that zero and then negative interest-rates ( a deposit rate of -0.4%) in the Euro has forced others in the locale to follow suit. It was and is a factor in the -0.5% of Sweden the -0.65% certificate of deposit rate in Denmark and the -0.75% of Switzerland amongst others. It is also a factor in the UK still remaining with a Bank Rate of 0.5% after so many years have passed and not following the more traditional route of aping the moves of the US Federal Reserve.

What next?

This is the question on many lips both inside for obvious reasons but also outside the Euro area for the reasons above. Why? Well the President of the European Central Bank Mario Draghi explained this earlier today in Frankfurt.

The economy has been growing consistently above current estimates of potential growth, by more than a percentage point last year. All euro area confidence indicators are close to their highest levels since the start of monetary union, even if the latest readings came in slightly below expectations.

This as I regularly point out means that monetary policy is facing a new frontier. This is because it is procyclical where it is expansionary in an existing expansion. Mario has in fact gone further than me in one area as in his view it is even more procyclical leading to output being more than 1% above potential. If that sounds a little mad I will return to it in a moment.  But another factor in this new frontier is the way that both negative interest-rates and QE have been deployed.

We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier ( Donald Fagen)

Potential Output?

Looking at what output has been allows us to figure it out.

Over the whole year 2017, GDP rose by 2.3% in the euro area ( Eurostat)

That would mean that potential output is only 1% per annum but I suspect Mario really means the 2.7% if you compare the last quarter of 2017 with a year before so 1.5%. That is rather downbeat which is very common amongst central bankers these days as for example Governor Carney and the Bank of England used different language “speed limit” for the UK but also came to 1.5%. Due to demographic pressures the Bank of Japan is even more downbeat for Nihon at 1%.

We will see how the media treat that as they make a big deal of the UK situation but let is move onto what causes them to think this? We come to something which is genuinely troubling.

Second, the degree of slack itself is uncertain. Even if slack is now receding, estimates of the size of the output gap have to be made with caution. Strong growth may be leading to higher potential output, as crisis-induced hysteresis may be reversed in conditions of stronger demand. And the effects of past structural reforms, especially in the labour market, may now be showing up in potential output.

As you can see the certainty of earlier has gone as this clearly points out they do not know. We are back to imposing theory on reality again and even worse a failed theory as later we get this.

Phillips curve decompositions find that past low inflation dragged down wage growth from its long-term average by around 0.2 percentage points each year between 2014 and 2017.

If we step back we see that according to the Phillips Curve wages should be soaring as we are above potential output whereas in fact they are doing this.

 The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

As in there is no link visible yet but if you inhale enough hopium it will be along at some point! Also I hope you enjoyed the reference to labour market reforms from Mario as we mull the contrast between that and his policy press conferences which every time without fail have a section calling for economic reform.

More! More! More!

It is somewhat awkward when you are telling people the economy is running hot and implying it is overheating if you also say it may be about to run faster.

Non-essential purchases – which make up around 50% of household spending in the euro area – tend to be postponed during recessions and then to catch up as the business cycle advances. Such purchases are currently only 2% above their pre-crisis level, compared with 9% for essential ones. This implies that discretionary household spending still has scope to support the expansion.

So it is below potential Mario? Also an area central bankers love to see boom also seems to be below potential.

Moreover, housing investment is still 17% below its pre-crisis level and is only now starting to pick up, which will likely add an extra impulse to the recovery dynamic.

What about inflation?

This if you look at a Phillips Curve world should be on the march in both senses as wages and prices should be heading upwards and yet.

Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016.

Not much is it? As to be fair Mario points out.

But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.

The trouble is the analysis seems to be based on pure hopium.

That said, our analysis suggests that, as the cycle advances, the standard wage Phillips curve should hold better for the euro area on average. The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

So when you really want it to work ( in a crisis) it fails and in calmer times it does not seem to work either. But they will continue with it anyway like someone who s stuck in the mud.


Actually I think that Mario Draghi is more intelligent than this as we see several themes come together. Back in the dim and distant days when I began Notayesmanseconomics I offered the opinion that central bankers would dither when it became time to reverse course on their stimuli. This became a bigger factor as the stimuli grew. Now we see a central banker telling us.

But we still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent.

This works nicely for Mario as the inflation forecasts remain below the 1.97% inflation target defined by a predecessor of his ( Monsieur JC Trichet).

The latest ECB projections foresee a pickup in headline inflation from an average rate of 1.4% this year to 1.7% in 2020.

Thus as he has hinted at in past speeches which more than a few seem to have forgotten Mario Draghi may depart as ECB President without ever raising interest-rates. In fact it seems to be his plan and it is something he will leave as a “present” for whoever follows him. Another form of stimulus may have slowed but is still around as well.

The cumulative redemptions under the asset purchase programme between March 2018 and February 2019 are expected to be around EUR 167 billion. And reinvestment amounts will remain sizeable thereafter.

So now we see that policy has been decided and a theory ( Phillips Curve ) has been chosen which is convenient. Mario may not believe it either but it suits his purpose as does claiming their has been labour market reform. This is the same way that we have switched from the economic growth of the “Whatever it takes” speech to inflation now both suggest the same policy which allows Mario to give himself a round of applause.

 Considering all of the monetary measures taken between mid-2014 and October 2017, the overall impact on euro area growth and inflation is estimated, in both cases, to be around 1.9 percentage points cumulatively for the period between 2016 and 2019.

So another masterly performance from Mario Draghi but it should not cover up the many risks from advancing onto a new frontier of procyclical monetary policy.





UK Inflation looks set to fall as 2018 progresses

Today brings us face to face with the UK context on what many are telling us has been the cause of the recent troubled patch for world equity markets. This is because a whole raft of inflation data from the consumer producer and housing sector is due. The narrative that inflation has affected equities markets has got an airing in today’s Financial Times.

The inflation threat has simmered for months, but the missing link had been wage growth, which made the rise in the US jobs figures for January so important, fund managers say. Indeed, the yield on the 10-year Treasury is 40 basis points higher this year, driven almost entirely by inflation expectations. Strong global economic data, coupled with sweeping tax cuts and the recent expansionary budget deal in Washington, should stir price pressures.

Actually that argument seems to be one fitted after the events rather than before as the rise in bond yields could simply be seen as a response to the expansionary fiscal policy in the US combined with interest-rate increases and a reduction albeit small in the size of the Federal Reserve balance sheet. Actually as the FT admits inflation is often considered to be good for equities!

While faster inflation would typically be good for stocks, lifting companies’ pricing power and suggesting economic growth is accelerating.


There is also a theme doing the rounds about wage inflation. Yesterday Gertjan Vlieghe of the Bank of England joined this particular party according to Reuters.

 a pick-up in wages ……..signs of a pick-up in wages

The problem for the Bank of England on this front is two-fold. Firstly it has been like the boy ( and in some cases) girl who has cried wolf on this front and the second is that the official data has picked up no such thing so far. Thus we are left essentially with one higher wages print of 2.9% for average hourly earnings in the United States. So the case is still rather weak as we wonder if even the current economic recovery can boost wages in any meaningful sense.


The first trend which should first show in the producer price numbers is the strength of the UK Pound versus the US Dollar over the past year. It was if we look back about 14 cents lower than the current US $1.388. Also the price of crude oil has dipped back from the rally which took it up to US $70 in terms of the Brent benchmark to US $62.47 as I type this. This drop happened quite quickly after this.

Goldman Sachs has held one of the most optimistic views on the rebalancing of the oil market and oil prices in the near term, and the investment bank is now growing even more bullish, predicting that the oil market has likely balanced, and that Brent Crude will reach $82.50 a barrel within six months. (

The Vampire Squid is building up quite a track record of calling the market in the wrong direction as back in the day it called for US $200 a barrel and when prices fell for a US dollar price in the teens. I will let readers decide for themselves whether it is simply incompetent or is taking us all for “muppets”.

Today’s data

The good news was that the trends discussed above are beginning to have an impact.

The headline rate of inflation for goods leaving the factory gate (output prices) rose 2.8% on the year to January 2018, down from 3.3% in December 2017…….Prices for materials and fuels (input prices) rose 4.7% on the year to January 2018, down from 5.4% in December 2017.

Tucked away was the news that the worst seems to be passing us as this is well below the 20.2% peak of this time last year.

The annual rate of inflation for imported materials and fuels was 3.5% in January 2018 (Table 2), down 1.7 percentage points from December 2017 and the lowest it has been since June 2016.

It is a little disappointing to see the Office for National Statistics repeat a mistake made by the Bank of England concentrating on the wrong exchange rate.

The sterling effective exchange rate index (ERI) rose to 79.0 in January 2018. On the year, the ERI was up 2.6% in January 2018 and was the fourth consecutive month where the ERI has shown positive growth.

Commodities are priced in US Dollars in the main.

Consumer Inflation

This showed an example of inflation being sticky.

The all items CPI annual rate is 3.0%, unchanged from last month.

However prices did fall on the month due to the January sales season mostly.

The all items CPI is 104.4, down from 104.9 in December

The inflation rate was unaffected because they fell at the same rate last year.

There was something unusual in what kept annual inflation at 3%.

The main upward contribution came from admission prices for attractions such as zoos and gardens, with prices falling by less than they did last year.

I will put in a complaint when I pass Battersea Park Childrens Zoo later! More hopeful for hard pressed budgets was this turn in food prices.

This effect came from prices for a wide range of types of food and drink, with the largest contribution coming from a fall in meat prices.

My friend who has gone vegan may be guilty of bad timing.

An ongoing disaster

The issue of how to deal with owner-occupied housing remains a scar on the UK inflation numbers. This is the way they are treated in the preferred establishment measure.

The OOH component annual rate is 1.2%, down from 1.3% last month. ( OOH = Owner Occupied Housing).

Not much is it, so how do they get to it? Well this is the major player.

Private rental prices paid by tenants in Great Britain rose by 1.1% in the 12 months to January 2018; this is down from 1.2% in December 2017.

If you are thinking that owner occupiers do not pay rent as they own it you are right. Sadly our official statisticians prefer a fantasy world that could be in an episode of The Outer Limits. They have had a lot of trouble measuring rents which means their fantasies diverge even more from ordinary reality.

If they had used something real then the numbers would look very different.

UK house prices rose 5.2% in the year to December 2017, up from 5.0% in November 2017.

This makes inflation look much lower than it really is and is the true purpose in my opinion. A powerful response to this at one of the public meetings pointed out that due to the popularity of leasing using rents for the car sector would be realistic ( they do not) but using it for owner-occupied housing is unrealistic ( they do).

If you want a lower inflation reading thought it does the trick.

The all items CPIH annual rate is 2.7%, unchanged from last month.


The underlying theme is that UK consumer inflation looks set to trend lower as 2018 progresses which is good news for both consumers and workers. The initial driving force of this was the rally of the UK Pound £ against the US Dollar and as it has faded back a little we have seen lower oil prices. We also get a sign that prices can fall combined with annual inflation.

The all items CPI is 104.4, down from 104.9 in December…..The all items RPI is 276.0, down from 278.1 in December…….The all items CPIH is 104.5, down from 105.0 in December.

One issue that continues to dog the numbers is the treatment of housing and for all the criticisms levelled at it a strength of the RPI is that it does have house prices ( via depreciation).

The all items RPI annual rate is 4.0%, down from 4.1% last month.

Meanwhile the Bank of England seems lost in its own land of confusion. It cut interest-rates into an inflation rise and then raised them into an expected fall! This is of course the wrong way round for a supposed inflation targeter. Now they seem to be trying to ramp up the rhetoric for more increases forgetting that they need to look 18 months ahead rather than in front of their nose. Perhaps they should take some time out and listen to Bananarama.

I thought I was smart but I soon found out
I didn’t know what life was all about
But then I learnt I must confess
That life is like a game of chess



What next for the UK economy and Bank of England policy?

Later this week the bank of England meets and votes on monetary policy. It will do this on Wednesday and announce the result on Thursday which is a newish innovation which frankly can only go wrong by being leaked. Also we will receive the quarterly Inflation Report so it is what you might call a “live” meeting as a policy move is more likely than at other meetings because of this. Last Tuesday Governor Carney made an effort to raise the rhetoric on the subject of inflation  From the House of Lords transcript.

We have further to go. The experience, particularly
over the course of the past decade, with large and persistent exchange rate moves is that there has been quite material pass-through to consumer prices and that that pass-through has come through over time.

In fact he expects the lower value of the UK Pound £ to continue to have an upwards effect on inflation for another couple of years or so.

Using a broad brush to describe how it flows through to CPI and people’s shopping baskets, we had about 40% of the effect in the first year, then 30%, 20% and 10%, so that it is tiny by year four……….We are about 18 months into this. Again, the rule of thumb is that in a big exchange rate move, about 60% goes to a first stage passthrough—in
other words, import prices—and the weight in the
consumption basket is just under 30%; or 30%, which I will use for the sake of argument. Given a 15% fall in the trade-weighted exchange rate, we should think about a 2.75% rise in the price level over time. Around 1.1% to 1.3% of the pass-through has shown up.

This is interesting as it would in itself justify an increase in Bank Rate to respond to this as there would be time for it to have some effect. Personally I doubt that as it looks yet again like something which might look neat in an economic model but has little contact with reality. I can see years one and two with the latter being where exchange-rate hedges and the like run off and lead to price rises but much much less if any for years 3 and 4. After companies like Apple and Unilever could hardly wait to raise prices as the Pound £ fell could they?Also I think it is important to remember that the main issue for price rises is the US Dollar because of the way that so many commodities are priced in it which leads me to this sentence.

. Of course, the farther out you go, the more other things are affected in terms of inflation and offsetting.

This at a later date can be used to cover the fact that there has been no mention that the UK Pound £ is now much higher against the US Dollar and at US $1.41 and a bit as I type this. This matters as the UK Pound £ has improved by a bit more than double ( ~17%) on my measure than on the effective one (~8%).


Bank of England optimism in this area is like a hardy perennial where even the bitterly cold winds provided by reality seem not to affect it.

We see it in the gradual firming of wages, particularly private sector wages, and particularly of people who are
shifting work.

The 3 monthly average has risen from 1.9% to 2.5% but that means that it was still lower than the 2.7% of the same month ( November) a year before. Also the single month data going 2.8%, 2.4% and then 2.3% hardly suggests a firming of any sort. Actually if you look at the issues with the data then the dip was the bonus season (April) and ordinary wage growth may well be pretty much where it was all along. A troubling answer but one which has fitted reality vastly better than the Bank of England’s modelling.

The economy

This has been doing well again to the dismay of economic modellers but this week has brought a couple of factors which are downbeat. One will be very familiar to regular readers. From the UK SMMT.

The UK new car market declined in the first month of the year, according to figures released today by the Society of Motor Manufacturers and Traders (SMMT). 163,615 cars were driven off forecourts in January, a -6.3% fall compared with the same month in 2017.

This makes us think of the car finance boom and second-hand car prices as well as ironically a fall in car imports which seemed on previous data to be disproportionately affecting French manufacturers. Another factor is the shambles around diesels which I doubt will improve as we learn that Volkswagen has been using monkeys in its tests.

However, this growth failed to offset a significant decline in demand for new diesel cars, which fell -25.6% as confusion over government policy continued to cause buyers to hesitate.

Also the latest business survey from Markit or PMI suggests that the UK economy slowed in January.

While the fourth quarter PMI readings were
historically consistent with the economy growing at
a resilient quarterly rate of 0.4-0.5%, in line with the
recent GDP estimate, the January number signals a
growth rate of just under 0.3%.

A little care is needed as the growth rate in the services sector has been erratic so we do not know if this will be a continuing dip or is an outlier.


Governor Carney was under pressure from the off as he faced the Lords Select Committee on Economic Affairs.

perhaps I may start by asking about the Bank’s projections for the economy in August 2016, particularly for business and housing investment and for imports and exports. Why did they turn out to be so wrong, relative to what has
actually happened?

This is much more than an idle question because these predicated the Bank Rate cut of August 2016 and the “Sledgehammer” bond purchases (QE). The Governor suggested that context was needed but was unable to shake off the issue completely in his reply.

On an annual average basis, not a calendar-year basis, there was 1.8% growth versus the 0.8% forecast.

If this was a boxing match then the Governor was trapped on the rails for a while.

I was struck by the fact that business investment, for example, which you suggested would fall by 2% in 2017, actually went up by 2.25% for the 11 months. You predicted that housing investment would fall by 4.7%, but it actually
went up by 4%.

It would appear that the Bank of England seems to be trying to set up something of an inflation scare after most if not all of it has passed. Maybe if we add in its optimism on wages it is tilling the ground for an interest-rate increase or two but this has problems one of which was highlighted by Markit earlier.

The January slowdown pushes the all-sector PMI
into dovish territory as far as Bank of England
monetary policy is concerned, historically consistent
with a loosening bias. With the survey also
indicating weaker upward price pressures, the data
therefore cast doubts on any imminent rise in
interest rates.

I think that the latter sentence reflects my view on inflation prospects more accurately than the Bank of England one but only time will tell. What we do know is that if we remain around US $1.41 then it will be an increasing brake on inflation trends. That should be good news as 2018 develops as it will help real wages and there should be an economic boost as real wages stop falling and hopefully rise from this source. It remains unclear whether wage growth will pick up.

Meanwhile the film industry seems to be continuing its recent boost to UK economic output if last night in Battersea Park was any guide.




The UK establishment dislikes the RPI because it produces a higher inflation number

Yesterday saw a new phase in a battle I have been fighting since 2012 with roots back to 2009. Back then some changes were made to the way the UK measured inflation in clothing and footwear that led to some uncomfortable answers. This triggered a debate about how we should measure inflation and the UK establishment immediately became fans of Steve Winwood.

While you see a chance take it
Find romance fake it
Because its all on you

You see over this period their behaviour can be summed up simply they are against inflation measures which give a HIGHER answer and in favour of ones which give a LOWER answer. Every time.

Governor Carney joins the party

It must have been party time for Chris Giles the economics editor of the Financial Times as he reported this.

Speaking to the House of Lords economic affairs committee, Mr Carney said the UK “wouldn’t want to be in the same position 10 years from now” using an inflation measure with “known errors” to uprate government bonds, student loan contracts and rail fares.

Indeed Governor Carney went further.

Mark Carney, Bank of England governor, on Tuesday called for a “deliberate and carefully timed” withdrawal of the retail prices index from its use in government contracts because “most would acknowledge, [the RPI] has no merit”.

There are some familiar features here of which the first is usually a combination of hyperbole and arrogance. For example to say that the RPI has “no merit” is plainly silly as whilst it has flaws it also has strengths of which more later. Also if it has “no merit” this should have been obvious from the start of Governor Carney’s term in July 2013 so why has he taken getting on for five years to notice it and then point it out? To use the Bank’s own language he has been “vigilant” with all that implies.

The next bit is maybe even more breathtaking.

He is the first senior official, outside of the UK’s statistics office, to call for the retirement of the RPI and to suggest a way to remove it in long term contracts, some of which stretch so far into the future that they mature in the second half of this century.

Is there an implication that existing contracts will be changed by a sort of force majeure? Care is needed here as the current landscape exists into the 2060s. Anyway the rhetoric continues.

The RPI has lost its status as a trusted inflation measure since 2012 when the Office for National Statistics found that an obscure change in the way it collected the price of clothing exaggerated the difference between it and other measures of inflation which show prices rising at a slower pace.

The use of “trusted” again overreaches. What happened it was declared as “not a national statistic” but it was also true that in the debate the RPI found support at places like the Royal Statistical Society from people like me. Actually some who have looked at this think that it was RPI which behaved more accurately over this period. So there has been a debate ever since and this raises a wry smile.

The ONS agreed that the RPI had errors, but the statistical office still refuses to improve its measurement after rejecting an expert committee’s advice to change the index in 2012. “RPI is not a good measure of inflation and we do not recommend its use,” an ONS spokesperson said.

I will leave you to decide whether Chris Giles is in fact an “expert” as he describes himself as he was on that committee ( CPAC) and voted  for imputed rents rather than house prices in CPIH. The problem with the “expert” description is that CPIH was later also declared not to be a national statistic because the rents numbers used in the imputed rents data were found to be wrong. This was something I predicted to Chris some 5 years ago when he spoke at the Royal Statistical Society.

The problems with inflation measurement

Let me give you some illustrations of good and bad features of UK inflation measures.


A good feature is that it covers owner-occupied housing mainly via the use of house prices via the depreciation component and mortgage interest-rates. It also covers the “average” better than most other measures by excluding some extremes. Apparently these have “no merit”.

The argument against centers on the “formula effect”

Mr Carney said the upward bias in the RPI was 0.7 percentage points a year.

Arguments have raged over the issue of a geometric mean versus an average one. This lead to the calculation of a variant called RPIJ  which was RPI without the “formula effect” and regular readers will have seen Andrew Baldwin’s eloquent arguments in favour of it in the comments section. Yet the UK establishment pressed the delete button on it after only a couple of years or so . Would it be rude to point out that it had consistently given higher readings than their preferred measures?


The arguments in favour of this are that it is consistent with national accounts methodology and that it avoids the formula effect. Against is the way that it omits owner-occupied housing and that it covers the better-off rather than the average person. This is because it is expenditure weighted and the fact that the better off spend more means it ends up about 2/3rds of the way up the income spectrum as opposed to the average,


This variant of CPI above, does cover owner occupied housing but as even the FT hints there is an enormous flaw in the way it does so.

includes an estimate of the housing costs of owner occupiers

That is simultaneously true and untrue. What it has via the use of imputed rent is an estimate of something which is never paid as home owners do not pay themselves rent as assumed. Again this fits with national accounts methodology at the expense of reality.



The truth is that there is no perfect inflation measure as every measure tries to measure the “typical” experience and we all vary in some way or another. There is a further nuance in that we can try to measure the cost of living or try to follow a purist economics/statistic measure based on consumption. Personally I think that the former is a better route as the Bank of England regularly finds out when it conducts its expectations survey.

Asked about expectations of inflation in the longer term, say in five years’ time, respondents gave a median answer of 3.5%, compared to 3.4% in August.

Another way of putting this is from a reply to the FT from Lu Xun.

The average 25 year old living independently of parents is spending 50-75 % of post tax income on rent in London.  Official inflation  of 2 % , 3 % , no matter if  RPI  or CPI ,  is entirely meaning less for the average punter.

The sad reality of the UK experience has gone as follows and see it you can spot a trend. We were told RPI ( 4.1%) was bad and was replaced by CPI (3%). For a while we were told RPIJ (~3.4%  ) was a possible way ahead but it got dropped whilst CPIH ( 2.7%) with its fantasy rents for owner-occupiers carries on as the “preferred” measure.

Meanwhile RPI carries on with more believers in it than the claim of it losing “trusted” status would have you believe. Yet it is not being updated ( a rather petulant act in my opinion) so it will over time increasingly have issues which when you consider it will be used into the 2060s is a decision of which those who made it should be thoroughly ashamed. Also let me agree with Chris Giles on one issue its use in areas where the government benefits and we lose but not the reverse is simply indefensible and wrong.

student loan contracts and rail fares.

Some care is needed though as some pensioners will have it in their contracts and of course what on earth will the Bank of England pension fund invest in going forwards ( 90% last time I checked)? A bit of a gap there between its rhetoric and behaviour.

However all is not lost as we do not have to go down the slippery slope from RPI to the CPIH as you see there is a new measure called HCI on its way. It looks like it will be a proper replacement for RPI as it does cover house prices so in a few years time once it begins to have a track record we could perhaps suggest beginning to move from RPI to it. It would have been much better if Governor Carney said that and also argued for the RPI to be properly updated in the meantime.

Those of you interested in finding out more about the proposed HCI will find more at the link below.

Number Crunching

You may be intrigued to know that an estimate of the effect of switching from RPI to CPI was that it raised GDP by around 0.5% a year. How? Well for the same outcome lower inflation means a higher recorded real output.


What are the consequences of a weak US Dollar?

So far 2018 has seen an acceleration of a trend we saw last year which is a fall in the value of the US Dollar. The latest push was provided by the US Treasury Secretary only yesterday at Davos. From Bloomberg.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

The way it then fell it is probably for best its value is not a concern as the rhetoric was both plain and transparent.

A day before Trump’s scheduled arrival in the Swiss ski resort of Davos for the World Economic Forum’s annual meeting, Treasury Secretary Steven Mnuchin endorsed the dollar’s decline as a benefit to the American economy and Commerce Secretary Wilbur Ross said the U.S. would fight harder to protect its exporters.

The response to the words is a pretty eloquent explanation of why policy makers have a general rule that you do not comment on the level of the exchange rate. Not only might you get something you do not want there is also the issue of being careful what you wish for! Sadly the Rolling Stones were not on the case here.

You can’t always get what you want
But if you try sometime
You’ll find
You get what you need

However you spin it we are in a phase where the US government is encouraging a weaker dollar as part of the America First strategy. It has already produced an echo of the autumn of 2010 if this from the Managing Director of the IMF is any guide.

 “It’s not time to have any kind of currency war,” Lagarde said in an interview with Bloomberg Television.

Criticising someone for rhetoric by upping the rhetoric may not be too bright. Also there are more than a few examples of countries trying to win the race to the bottom around the world.

What does a lower US Dollar do?

Back in November 2015 Stanley Fischer gave us the thoughts of the US Federal Reserve.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.The gradual response of exports reflects that it takes some time for households and firms in foreign countries to substitute away from the now more expensive U.S.-made goods.

Also imports are affected.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

This means that the overall economy is affected as shown below.

The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years. Moreover, the effects materialize quite gradually, with over half of the adverse effects on GDP occurring at a horizon of more than a year.

Okay we need to flip all of that around of course because we are discussing a lower US Dollar this time around. Net exports will be boosted which will raise economic output or GDP over time.

How much?

If we look at the US Dollar Index we see at 89.1 it has already fallen by more than 3% this year. The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%. The official US Federal Reserve effective exchange rate has fallen from 128.9 in late December 2016 to 116.8 at the beginning of this week so 116 now say. Conveniently that gives us a fall of the order of 10%.

So if we look up to the preceding analysis we see that via higher exports and reduced imports US GDP will be 1.5% higher in three years time than otherwise.

What about inflation?

There is a lower impact on the US because of the role of the dollar as the reserve currency and in particular as the currency used for pricing the majority of commodities.

While the Board staff uses a range of models to gauge the effect of shocks, the model employed in figure 4–as well as other models used by staff–suggests that the dollar’s large appreciation will probably depress core PCE inflation between 1/4 and 1/2 percentage point this year through this import price channel.

You may note that Stanley Fischer continues the central banking obsession with core inflation measures when major effects will come from food and energy. It would be entertaining when they sit down to luncheon to say that we are having a core day so there isn’t any! Have you ever tried eating an i-pad?

So inflation may be around 0.5% higher.

What about everybody else?

The essential problem with reducing the value of your currency to boost your economy via exports is that overall it is a zero-sum game. As you win somebody else loses.  So the gains are taken from somebody else as no doubt minds in Beijing, Tokyo and Frankfurt are thinking right now. Of course pinning an actual accusation on the United States is not easy because of its persistent trade deficits.

Furthermore the exchange-rate appreciation seen elsewhere will not be welcomed by the ECB ( European Central Bank) and particularly the Bank of Japan. The latter is pursuing an explicit Yen depreciation policy to try to generate some inflation whereas what it has instead seen is a rise towards 109 versus the US Dollar. Of course workers and consumers will have reason to thank the lower dollar as lower inflation will boost their spending power.

Later today we will see how Mario Draghi handles this at the ECB policy meeting press conference. He finds himself pursuing negative interest-rates and still substantial if tapering QE and a stronger currency. It is hard for him to be too critical of the US though when even Christine Lagarde is saying this.


Of course that takes us back to a past competitive depreciation which Germany arranged via its membership of the Euro.


There is a fair bit to consider here. As it stands it looks as though the US economy will benefit over the next 3 years (convenient for the political timetable) by around 1.5% of GDP at the cost of higher inflation of 0.5%. There are two main problems with this type of analysis of which the first is simply the gap between theory and reality. The smooth mathematical curves of econometrics are replaced in practice by businesses and consumers ignoring moves for as long as they can and then responding but by how much and when? So we see a succession of jump moves. The other issue is that exchange-rates are usually on the move and can change in an instant unlike economies leaving us wondering which exchange-rate they are responding too?

Next we have the awkward issue of a country raising interest-rates and seeing a currency depreciation. Theory predicts the reverse. I have a couple of thoughts on this and the first is about timing. In my opinion exchange-rates these days move on expectations of an event so they have already happened before it does. So the current phase of interest-rate rises was reflected in the US Dollar rise from the summer of 2014 to the spring of 2015. That works because if anything we have seen fewer rate rises than expected back then and the bond market has fallen less. As to the Federal Reserve well with the US Dollar here and inflation with a little upwards pressure it will therefore find a scenario which makes it easy for it to keep nudging interest-rates higher.

Meanwhile there are other factors which are hard to quantify but seem to happen. For example a lower dollar coming with higher commodity prices. Hard to explain and of course there are other factors in play, But it seems to have happened again.

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Was the UK productivity crisis just an illusion?

This morning has brought fascinating news confirming one of the main themes of this website and indeed my work. I regularly point out that there are more than a few problems with converting economic theory to practical measurement. It is also true that economic statistics are quoted in the media and elsewhere to an accuracy they simply do not possess of which the clearest example is the quoting of quarterly economic growth or GDP ( Gross Domestic Product) figures to an accuracy of 0.1%. Strangely the official statisticians in my country the UK seem to want to exacerbate this problem by producing monthly GDP reports when there are such issues with the quarterly ones. After all the initial or preliminary quarterly report only contains around 40% of the final data set so producing monthly reports seems more like flying on a wing and a prayer to me.

However there is a positive here which is work from the Economic Statistics Centre of Excellence has shown a way we can do better and on that road we find that as we have suspected on here the group Imagination were rather prescient about some official data.

Could it be that it’s just an illusion
Putting me back in all this confusion
Could it be that it’s just an illusion now?

The Telecoms Problem

The issue here is summed up quite simply by the sentence below.

The telecommunications services industry has experienced very large technological progress in the past decades, as measured by technological output metrics. However, the industry’s economic output statistics do not appear to reflect this.

As that sinks in we realise that there is quite a problem here. After all if there is an area where there has been technological progress telecommunications is where it has been. I realise that I am spoilt being a Londoner in terms of signal strength but for example pretty much everywhere you these days there are people connecting online via their smartphones. Or in another form the Uber business model pretty much relies on people being connected online and my part of town became for a while like a science fiction film with so many people staring at phones checking where their taxi had got to. Another variation of this has been increases in broadband speeds and falls in price as I recall being a customer of AOL Silver providing a grand speed of 256k! Hard to believe now that I was paying £17 a month for that isn’t it?

There is a business context to this as at the turn of the century I was looking at having some trading systems connected to my flat. It seems like another universe now that BT wanted £6000 to connect up and at least £1000 a month for something which now would cost say £50 a month and probably less.

Yet as the authors of the paper point out this is how it has been officially recorded.

Between 2010 and 2015, for example, data usage in the UK expanded by around 900% but real Gross Value Added (GVA) for the industry fell by 4%.

Gross Domestic Product

It looks as though this has been underestimated over the period in question.

there has been an exponential growth in the quantity of data transmitted via telecommunications networks (both fibre and wireless) in recent years. Intuitively, this huge gain in achieved data transmission performance at the same or declining cost should represent a significant gain in output, irrespective of the content transmitted by the data, or the price charged for this content.

There are two issues here. Firstly the explicit one which is that output from this sector has been underestimated and thus GDP will be higher once it is properly recalculated. Next is the implicit one that we need to check other sectors as whilst they may not be affected as much there may be impacts.


This is the crux of the matter. Here we find that two of my themes get backing and the major one that economic advancement can come from lower prices has a shattering effect on central banking methodology. Advancement via lower prices makes a 2% inflation target look out of touch and those arguing for an increase to be somewhere far far away, to coin a phrase from reality. Next there is the issue of deflators, which is how inflation is measured for GDP, and it is something of a mess. The particular issue here is that GDP in this sector has been too low because recorded telecoms inflation has been too high. In fact way too high.

Our findings indicate that the current deflator is upward biased and that telecommunications services
prices could have fallen between 35% and 90% between 2010 and 2015, considerably more than the current deflator,

This is a specific problem but in fact there are more than a few issues with the deflators in the national accounts. The worst sector is the one for government which seems to me to be an outright fantasy. This is not a criticism of the individual statisticians who no doubt do their best but an observation that in reality we have no real way of measuring it mostly because we have no output measure for more than a few government sectors.


I have regularly argued that it is very likely we have miss measured productivity and therefore the crisis will to some extent fade away. We have today seen at least a partial confirmation of this highlighted by this from the Financial Times last March.

Telecoms accounts for only 1.8 per cent of the economy but official data suggest it is responsible for nearly a fifth of the economy-wide productivity slowdown.

It now appears that the productivity problem in this sector was because output was recorded incorrectly ( too low) because inflation via the deflators was too high.

If we go back to the peak headlines where for example the Bank of England argued we were some 19% below where we would have been projecting pre crisis trends we are left wondering how much is due to miss measurement?


There is a lot to consider here as we see yet again that our economic concepts may be fine in theory but are much more difficult in practice. This is especially true in the services sector where the output is usually intangible as opposed to the tangible output of the goods sector. That is especially awkward when the services sector is heading for 4/5 ths of your economic output as it is in the UK.  The analysis in the paper referred too highlights this in one simple section which shows that in the period in question telecoms revenues fell by 10% which in essence led to the falling output and productivity conclusion in UK GDP. But data transmission rose by a factor of ten strongly challenging the falling output conclusion. Another way of looking at that is the existence of a wide range of business and services such as WhatsApp or Kik.

It is a mistake I think to just take the data numbers as issues such as allowing for quality and what is called hedonics have problems. I still recall being at a Public Meeting on the subject of inflation measurement and a questioner from the floor  pointed out that his grandmother particularly liked one apple ( Cox’s Pippin) and if they were not available would not buy apples as opposed to in economic theory where she would automatically switch to a different variety. Thus I would agree with the research paper that the middle way of modifying the inflation measure by 35% rather than 90% is sensible but it comes with a crucial kicker. This is that whilst the numbers are now more realistic and should be much more realistic we should have a slice of humble pie and realise that they are if you will forgive the capitals an ESTIMATE as opposed to the holy grail.

For those who wish to read the paper I have put a link below.

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