Adding her voice to concerns about the credibility of official inflation figures, the economist Kate Barker
CBE has urged the UK Statistics Authority to encourage the ONS to conduct its investigation into the Consumer Price Index (CPI) “as swiftly as possible, but without skimping on sound consultation or on statistical resource.”
In a letter dated 6 January 2012 Ms Barker, who served on the Bank of England’s Monetary Policy Committee
(MPC) from 2001 to 2010, said “it might have been preferable for the shift towards the wider use of the CPI to have been delayed until the known weaknesses of this measure had been addressed, and the differential with RPI [Retail Price Index] fully understood. Early resolution and of, and honesty about, these issues seems vital to retain public confidence.”
In December 2003 the CPI inflation rate replaced one based upon the RPI as the Bank of England’s monetary policy target. Subsequently, it has been applied as the statutory measure of inflation to revisions of public-sector pensions and state benefits.
Ms Barker’s letter highlighted some the differences in how the two measures are calculated, specifically the CPI’s exclusion of housing costs, inclusion of university accommodation fees and its use of the ‘formula effect’ to reflect consumers’ substitutions between goods and services as relative prices changed. “Overall, there seemed little reason … to object to the use of CPI as a reasonable definition of inflation for use as the target variable for monetary policy,” she commented.
But she went on to catalogue some of the CPI’s disadvantages in the public perception of inflation. “Firstly, the rapid rise in house prices led to a view that the CPI was a misleading target for monetary policy. This view is largely mistaken, but the present composition of the CPI makes it hard to refute. Secondly, it added to existing confusion in commentary about wage increases, due to the unfortunate habit in some parts of the media of referring to any wage increase above the present inflation rate as ‘inflationary’ (which it obviously may or may not be).”
Ms Barker also drew attention to “the widening of the formula effect from 2010, increasing the gap between RPI and CPI has added to concerns”. The formula effect keeps the RPI inflation rate – which uses an arithmetic mean at the lowest level of aggregation – consistently higher than the CPI rate, which uses a geometric mean. At the time of the move of the inflation target to CPI ,the RPI was about 0.75–0.8 per cent higher than CPI, but analysis from the Office for Budget Responsibility
, published in November 2011, implies this gap could widen to 1.3-1.5 per cent.
“The question of whether the geometric mean is appropriate to use in the aggregation of prices turns on how far products within a particular grouping are substitutes for the consumer,” wrote Barker. She also highlighted the complexities of measuring housing costs, “as the rental and owner-occupied sectors of the housing market are not perfect substitutes.”
Furthermore, “the change to uprating pensions in some defined benefit schemes by CPI has changed the relationship in some actuarial calculations between projections of price and wage inflation. Alterations to the CPI may shift this relationship again, altering estimates of pension deficits or surpluses,” she observed.
Ms Barker acknowledged that “There is of course no perfect way to measure inflation, and … I certainly do not wish to imply that there should be a return to the RPI.”
But her concern was the possible implication that “the shift to the CPI as presently calculated means that the UK has gone from using an inflation rate which overstates the cost of living to one which understates it. It would therefore seem particularly urgent for the ONS to resolve the question of the choice of formula for all product groups. At present the ONS aims to have considered elasticity of substitution estimates by July 2012. It is very important that their conclusions can then be published for wider discussion and consultation before the CPI calculation is amended.”