By Andrew Sentance, Senior Economic Adviser, PwC
Yesterday, the Office for National Statistics announced that it would introduce a new measure of UK inflation – RPIJ.
Before the introduction of RPIJ, there were already a wide range of UK inflation measures.
In the beginning was the Retail Prices Index (RPI). The RPI was first calculated in 1947 and over the years it has become invested with great status. Until recently, any changes in the RPI had to be agreed by the Retail Prices Advisory Committee (RPIAC), which included representatives from the CBI, TUC and learned academics. I was a member of the RPIAC in the late 1980s and early 1990s when I was working at the CBI.
The first breach in the RPI wall came in the early 1980s, when the Thatcher Government was cutting direct taxes but also increasing indirect taxes. In wage bargaining discussions, it was felt that this “tax switch” was not recognised. So the Tax and Prices Index (TPI) was born. The TPI aimed to take into account the impact of reductions in income tax and national insurance which might offset higher VAT or other indirect taxes.
The second major change came in the late 80s and early 90s when the focus switched to RPIX – a measure of RPI inflation excluding mortgage interest payments. In 1975, a decision had been taken by the RPI Advisory Committee to include mortgage interest payments in the UK RPI. In the rip-roaring era of high inflation and relatively stable interest rates in the mid-70s this didn’t make much difference. But when the UK government was raising interest rates to curb inflation in the late 1980s it became bigger issue – appearing to add to inflation when it was already high.
RPIX inflation therefore became the key measure of UK inflation when the era of inflation targeting started in 1992. It was the main focus of economic policy from then until 2004.
The third big change came in the late 90s and early 2000s when it was recognised that the methods used to calculate RPI were not in line with general international practice. A harmonised approach to calculating consumer price indices was agreed within Europe (HICP) and the UK started to publish an index of inflation calculated on this basis in 1996. From 2004, this became the measure of inflation used by the Bank of England, targeting a 2% rate.
Alongside these broader changes, other variant measures of inflation have been developed and published on a regular basis. RPIY and CPIY adjust these respective indices for indirect taxes. We also have CPI-CT which calculates what the CPI would be under a constant level of indirect taxes. And last summer, the ONS announced it would publish an index called CPIH, which incorporates within the CPI a broader measure of housing costs.
Before the ONS announcement about RPIJ, we had eight possible measures of consumer/retail price inflation. Now we have nine. We could also add to that measures such as the GDP deflator and the Consumer Expenditure Deflator, which are based on the UK national accounts.
The good news is that these measures currently show a broadly consistent picture. The GDP deflator is the lowest – rising by 2.2% over the past year - and the RPI is highest at 3%. With so many measures of inflation, this is a remarkably narrow range. The Bank of England’s target measure – CPI – is around the middle of the range at 2.7% so it is hard to argue that this measure is giving an unreasonable view of UK inflation.
But with so many measures of UK inflation already, do we really need RPIJ to measure the rate of increase in UK prices? I think not. We should try and narrow down the range of inflation measures – particularly focusing on the CPI – and promote the better measures, rather than inventing new ones.
Andrew Sentance | Telephone: +44 (0) 20 7213 2068