The ONS puts consistency first

 
Mathematician writes out formula on a blackboard

Britain's Office for National Statistics has decided, when it comes to inflation, it's better to be consistent than to be right.

It is not going to seriously change the way that Britain's oldest inflation index is calculated, even though that goes against the recommendation of its own Advisory Committee and many international bodies such as the International Monetary Fund.

Those in the financial markets who had bet on a different outcome will be disappointed. So too will the Chancellor - who stood to save billions a year in debt interest from the change.

Economists and statisticians who think the Retail Prices Index (RPI) is seriously flawed won't be happy either. Many of them thought a change was long overdue.

But, anyone with a pension or investment that is still linked to the RPI will be deeply relieved. There are nearly £300bn-worth of index-linked government bonds, or gilts. Countless other investments and pensions are linked to it as well.

If you're dependent on an index-linked annuity, the change being contemplated by the ONS could have cut its value by 15% over 20 years, with the cost widening every year.

Coming on top of the other savings that the government has been making, that would have been a serious blow. Even if many economists would say that the change had made the index more accurate.

Carli v Jevons

If we were creating the Retail Prices Index from scratch, the National Statistician, Jil Matheson, admits that we would not design it the way it is now.

The Carli formula - which is used to generate nearly 30% of the RPI - has some strengths, but is not used by any other serious statistical body in the world because it tends systematically to overstate inflation, especially when prices for a certain good are highly variable.

If the prices of clothes rise very sharply, then come back down to where they were, you might think that an inflation index should show no overall change. That is what the Jevons method - used in the Consumer Prices Index (CPI) and around the world - would show.

But the Carli formula would say there had been some inflation - even though prices are back to where they were at the start.

The Jevons (geometric) method also takes greater account of the fact that consumers tend to switch to other products if one becomes more expensive. Whether that makes it better than the Carli depends on the good you're talking about, but many statisticians consider it another plus.

So much for the statistical niceties. What difference does it make?

By itself, this difference in formula has tended to make the RPI 0.9 percentage points higher than the CPI, on average, since 2010. (That was when they changed the way they collected price data for clothes. Before that, the formula effect led to a difference of around half a percentage point.)

Remember, that's independent of any difference between them that is caused by the fact that more housing costs are included in the RPI.

That sometimes makes it lower than the CPI and sometimes makes it higher. You might remember that RPI inflation rate went negative in 2009, when interest rates were falling sharply, whereas the CPI measure never went below 1%.

Serious consideration

The point about the formula effect is that it systematically pushes the RPI higher, relative to the other index, when inflation is positive.

So, time for a change, many people thought. But in weighing this decision, the ONS also had to weigh the interests of the millions of people who hold investments and pensions that are linked to the RPI.

In effect, Ms Matheson has decided to put them - and the historical integrity of the index - before anything else.

As I said, it will be a shock for the City: the shorter-term index-linked bonds, which have suffered in the past few months as a result of the consultation, will probably go up today. But some inside the ONS will not be surprised.

I served briefly on the Consumer Prices Advisory Committee, set up a few years ago to advise on such changes, along with other outsiders like the FT Economics Editor and representatives of the Bank of England and the CBI.

I left before they got into discussing this issue. But even from the few meetings I attended, it was clear that people at the ONS take the historical consistency of the RPI very seriously indeed.

I often have to explain why GDP and other economic statistics have been revised down - or up. You might have noticed that that never happens with the CPI or RPI. There is just too much money riding on them.

Once released, the inflation numbers stand for all time, even if it turns out someone has made a mistake. The RPI does not get revised. And looking ahead, the ONS has decided it's not going to be seriously updated, either.

Update: 11.28 GMT

The FT's Economics Editor, Chris Giles, has been much more pointed in his coverage of the RPI decision. (As I mentioned earlier, he still serves on the Consumer Prices Advisory Committee, which favoured a change in the RPI formula).

He says he "cannot think of another occasion when national statisticians have discovered a major conceptual error and decided to do nothing about it".

He also disputes my suggestion that the RPI has been historically consistent, pointing out there have been many changes over the years, like the introduction of mortgage interest payments, which make it very different today from when it started in the late 1940s.

This paper from the ONS outlines the history of these changes, some of them fairly significant.

Looking at the list, it's hard to see a change that systematically affected the value of the entire index, in a single direction, as much as dumping the Carli formula would have done.

Still, you might say the size of the change doesn't matter. The point is that they have made changes before, in order to make the index more accurate, even at the cost of making it less consistent over time.

If the ONS believed this change would also improve the quality of the index - why not go ahead?

In looking for an answer, it's hard to escape the conclusion that the size of the change did matter, a lot. The National Statistician looked at the sheer scale of the financial impact, and the public response to the consultation (more than 80% opposed the change, almost always for financial reasons), and just couldn't stomach it.

Some will find the decision welcome, and understandable - especially those who think the RPI and the CPI are both a poor reflection of the inflation faced by pensioners.

As Robert Peston has pointed out, holders of indexed gilts could argue that they paid for the inflation protection offered by the traditional RPI, and they are legally entitled to get it.

Others will say the ONS chickened out.

But critics of this decision are right to emphasise one point. It's not just the Chancellor that loses out - it's all of us, in our capacity as taxpayers.

If, as the ONS itself accepts, the RPI has an "upward bias", then we as taxpayers have been over-compensating investors for the impact of inflation, to the tune of billions of pounds a year.

Thanks to this decision, we're going to carry on overcompensating them.

It's worth pointing out that any young person with a student loan will also lose out, because their official loans are indexed to the RPI. Rightly or wrongly, the ONS has put the interests of pensioners and bondholders first.

 
Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

So it's goodbye from me

After 11 years at the BBC, I'm leaving for a new role in the City.

Read full article

Comments

This entry is now closed for comments

Jump to comments pagination
 
  • rate this
    +3

    Comment number 33.

    Stephanie

    The 80% opposed to changing the RPI methodology included the Royal Statistical Society.

  • rate this
    +1

    Comment number 32.

    The ONS have got this exactly right. They lacked the authority to make such a political decision, and have instead created an new index (RPI-J) that the government can switch benefits to via legislation, if it chooses.

    Gilt investors have not benefited unfairly. The extra value in the RPI formula was reflected in the (higher) price they paid when they first bought their gilts from the government.

  • rate this
    +5

    Comment number 31.

    27.thecoopster

    I'm not in the age category that you mention but to be fair to them the boomers had to put up with dirty hard manual jobs, massive inflation, 3 day week, crippling strikes, much poorer health etc so it wasn't all champagne and strawberrys for them either. That generation also didn't expect endless handouts like many of this one either

  • rate this
    -1

    Comment number 30.

    Please define

    "not going to seriously change"

  • rate this
    0

    Comment number 29.

    My weekly groceries shoping costs went up 50% in two years, utilities and rent are up 10% YoY but CPI and the RPI were telling me inflation was around 4%

    The choice of items & weights in the baskets of goods used is such that the indexes yield lower values that the inflation most people experience

    Remember: inflation numbers that are less than real inflation produce larger GDP growth numbers

  • rate this
    +1

    Comment number 28.

    'Not a yes man' ( at 8 in these comments ) has rightly questioned the competence of the ONS and whether they were following government suggestions to find a way to push down the results for the RPI inflation measure.

    He vividly describes the public consultation meeting at

    http://bit.ly/UCjd5X

  • rate this
    -6

    Comment number 27.

    So in addition to free bus passes and fuel allowance, on top of the fact that houses cost them much less and their pensions are already way better, the older generation is to have its index linking protected as well.

    If you were born between about 1935 and 1960 you won life's lottery big style. Born after ~1980 and you're screwed. And the government is helping the former category the most!

  • rate this
    +10

    Comment number 26.

    Neither CPI or RPI seem to reflect the true cost of living. We are constantly told by Gov & economists that inflation is low & yet those things that we all need to buy like fuel, food & transport are increasing in price hugely - all the while wages (& benefits) are lagging way behind. Affordability & cost of living is a huge problem in this Country, look at the number of people using food banks

  • rate this
    +1

    Comment number 25.

    The substitution idea is questionable because it makes assumptions about consumer behaviour and knowledge. To put it crudely if a price goes up do the index makers scour the shelves of Aldi, home bargains etc for substitutes and where do they go to get their original price - Waitrose or Asda? There is something to be said for an essentials cost of living which I suspect will be well above even RPI

  • rate this
    +1

    Comment number 24.

    "5.Actionr
    We all know that the actual inflation is much much higher than either CPI or RPI....People dont eat electronics and laptops for lunch or dinner."

    No, but people do spend money on them so they should be in the inflation statistics.

    People might buy milk more *often* than laptops, but add it up over many years and the amount spent on milk and laptops is probably similar.

  • rate this
    +2

    Comment number 23.

    Nothing like an HYS on anything mathematical to show how inumerate we are as a nation....

  • rate this
    +1

    Comment number 22.

    #19 agree we probably need a number of different index to better reflect what is actually happening , then we might get better adjustments in policy too

  • rate this
    -1

    Comment number 21.

    Just as well that the basis for calculating the RPI will not be changed.

    It saves me having to take a judicial review claim to the High Court and the Office of National Statistics losing the case.

    I rely on the continuity of RPI for my occupational pension uplift and for my index linked gilts investment. Those investments were made expecting that the RPI basis would remain unchanged.

  • rate this
    0

    Comment number 20.

    Any form of inflation measurement that assumes substitution (i.e. we buy fewer products that have increased in price and substitute for cheaper items) tracks not the "cost of living" but the "cost of survival".

    Does anybody take this silly numbers seriously anyway? Inflation is at least twice the official figure.

  • rate this
    +1

    Comment number 19.

    What we really need is an Essential Prices Index covering the things an individual or household really need to buy. This would not include discretionary spend items but would include taxes.

    That would more accurately reflect the cost of living. A similar index could be provided for businesses.

  • rate this
    +1

    Comment number 18.

    > it's better to be consistent than to be right

    All the thickies in our government might have a hard time with this, but the name, RPI, relates to the methodology.

    If you choose another methodology, then you choose another name.

  • rate this
    -3

    Comment number 17.

    "ONS take the historical consistency of the RPI very seriously indeed"
    They take it seriosly because it effects THEIR PENSIONS!

    The big loosers would have been Civil Servents pensions as they are linked to RPI. There will now be two tier inflation. A rate for gold plated government pension increases and a rate for the plebs!

    Have turkeys ever voted for Christmas!!!

  • Comment number 16.

    All this user's posts have been removed.Why?

  • rate this
    0

    Comment number 15.

    'Britain's Office for National Statistics has decided, when it comes to inflation, it's better to be consistent than to be right'

    It's better to be consistently wrong then? Amazing stuff

  • rate this
    +20

    Comment number 14.

    Both sets of indices do not actually follow the true cost of living. We need one that is based on basics EG a standard shopping basket with just essentials, heat/light, car running costs Etc. Rather than the costs of a flat screen TV, horse livery Etc. All of which we see pensioners buying every week. What we need is something that can't be manipulated and gives us a true indication of inflation.

 

Page 7 of 8

 

Features

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.