Case for a single inflation measure

Friday 11 January 2013

The expectation had been that it would be RIP for RPI.

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However, the Office for National Statistics (ONS) defied many of the experts yesterday by announcing a reprieve for the Retail Prices Index, which has been plotting UK inflation ever since 1947. The review had been ordered in a bid to reduce the gap between RPI and the Government's preferred (and generally lower) Consumer Prices Index (CPI). These calculations matter because of their implications for many services and investments, including rail fares, Government bonds and many final salary pensions. The cumulative effect of consistently under- or over-estimating inflation could affect an individual's retirement pension by many thousands of pounds and alter Government debt repayments by billions.

No method of calculating inflation is perfect but RPI has a particular flaw. If prices rise sharply, then return to where they were, the formula used in RPI would still show some inflation. This quirk, rather than the difference in the list of items on which the calculations are based, accounts for most of the difference between the two measures since 2010.The biggest loser from yesterday's decision is the Treasury because eliminating the arithmetical flaw in the calculation could have saved it up to £4 billion in interest on its debt payments. Other losers will be rail commuters and those paying off students loans because RPI is used to calculate those too. So why keep RPI if, as its critics maintain, it overstates inflation? Much of the lobbying to retain RPI came from bodies such as Saga and was built on fears of a stealth attack on pensioners. They have a good case. The annuities on which pensioners rely have been badly hit already by the Government's quantitative easing scheme. Adjusting RPI, even by less than 1%, would slash retirement incomes for those in a typical final salary pension by nearly £10,000 over 20 years, according to Hargreaves Lansdown. Unlike other age groups, pensioners have little scope for increasing their incomes. Besides, many question whether RPI really does over-estimate inflation, especially as it is experienced by pensioners. That is because they typically spend much of their income on groceries and utilities, two areas where price rises have easily outstripped both standard measures of inflation since 2010.These are all valid arguments. However, once again a major decision – made in this case by the independent ONS – appears to favour the older generation over both the young and middle-aged. It is bad news for a young graduate, paying off student loans and obliged to buy a rail season ticket. Meanwhile public sector workers, with frozen wages and pensions that have been switched over already to CPI uprating, face lower incomes in real terms both now and in retirement. But even they look privileged alongside the welfare claimants who last Monday saw annual inflation uprating replaced by a 1% cap until at least 2016. The ONS failure to grasp this nettle merely draws attention to the fact that the UK still needs a single inflation measure that is both fair and accurate and a Government capable of ensuring none of its citizens is left behind.

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Finance

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Case for a single inflation measure

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