THE UK’s national statistician did something extraordinary this week.
After a two-year inquiry, Jil Matheson concluded that the formula used to compute our oldest measure of price inflation, the retail prices index or RPI, “does not meet international standards”. She recommended that a new index that does meet these standards be published.
Called “RPIJ”, it will start appearing in March. RPIJ is expected to come in quite a bit lower than the typical RPI monthly measure of inflation. For instance, when RPI hit its most recent year-on-year high, of 5.5 per cent, in February 2011, RPIJ, had it been around, would have come in nearer 4.5 per cent. However, our top number cruncher stopped short of pronouncing RIP on wonky old RPI.
After consultations revealed “significant value to users in maintaining the continuity of the existing RPI’s long-time series without change”, she decided old-style RPI should continue to be crunched and published each month to be used in everything from determining rises in rail fares and utility bills to returns on a range of National Savings products, from calculating annual increases in many private occupational pensions to determining returns to investors on index-linked government securities or gilts.
Her decisions came despite advice from an ad-hoc advisory panel that RPI should be radically reformed to make it statistically sound. But they were rubber-stamped by the UK Statistics Authority, which oversees the work of the Office for National Statistics. And the UK government, which has moved the calculation of public sector pensions over to the more internationally respectable – and typically lower – measure of inflation, CPI, seems reluctant to intervene, at some significant cost to itself.
All of which raises some big questions. If RPI – being based on what Tim Harford of BBC Radio 4’s More or Less programme has called “some dodgy old maths from 18th century Venice” – consistently over-estimates the actual level of price inflation month by month, what precisely is that “significant value” our national statistician believes should continue to be enjoyed by its users?
Surely it is rail operating companies being able to profit from fares pushed higher than justified by rises in their costs; those lucky enough to be members of functioning private pension schemes getting increases greater than justified by actual rises in the cost of living; and investors all round the world enjoying higher returns on UK gilts than real indexation would demand.
Their gain inevitably means more pain elsewhere. Commuters and travellers risk being priced off trains. Companies sponsoring deficit-plagued final salary pension schemes confront funding shortfalls even greater than they need be.
A more accurate RPI could, at a stroke, have slashed some £20bn from currents scheme deficits. And, on some estimates, the over-indexation of gilts is already costing the UK around £3bn a year, money that can only be recouped by higher taxes or more spending cuts.
A dose of self-inflicted statistical austerity then. So why hasn’t George Osborne intervened? The Treasury, over which he presides, has even let it be known that new issues of indexed gilts will continued to be pegged to old-style RPI. Could it be the Chancellor doesn’t want to alienate an important constituency – better-heeled pensioners – in the run-up to the next election in 2015?
And might he be anxious not to spook the bond markets at a time when the UK, despite all his earlier promises to the contrary, risks losing its AAA credit rating?
Because, at its root, this problem is about obscure mathematical procedures, it does not generate the kind of political heat that has surrounded the Westminster coalition’s decision to up-rate most welfare benefits by only 1 per cent in each of the next three years. But, as we have already seen, some of the consequences of continuing to use RPI speak to the same issues of equity and fairness.
RPI has been measured in the UK since 1947. The basket of goods and services it measures differs, in some respects, from those surveyed for CPI inflation, the measure that now sets pubic-sector pension rises and is targeted by the Bank of England in setting monetary policy. The other big difference lies in the formulae used to average out changes in individual prices to come up with a headline inflation number.
That divergence came to head in 2011 over how to track price changes in clothing and, in particular, in women’s dresses. In October 2011, RPI inflation in clothing and footwear had hit 12.6 per cent, while the CPI measure in the same category in the same month was running at just 3.6 per cent. What was going on?
Were the data collectors measuring different things? Some dropping in to Primark, while others were visiting designer outlets? Could items be more rigorously defined? One pilot defined a formal dress as one that had to be lined, while a casual dress had no lining. But besides sampling issues, it became clear that the different formulae used to compute average inflation were responsible for a large part of the problem.
The arithmetic Carli Index formula, developed in 1764 by the Venetian economist Count Carli, still plays a major role in calculating RPI. It has long been known to inflate the actual level of price inflation, even pointing to rises when prices are stable.
It as been widely discredited around the world. Canada abandoned it in the 1970s, Australia and the United States in the 1990s. The UK is the only economy to retain its dubious services.
We also use the alternative geometric average approach of the Jevons formula in computing the CPI measure of inflation. Named after a 19th-century English economist, Jevons is the “J” in the new RPIJ measure, due to make its entrance in March. But it’s far from clear, given CPI’s already available, who is going to want to use it. Certainly not the vested interests which lobbied hard to retain an unreformed RPI and got their way.
If our national statistician believes RPI, as currently devised, does not meet international standards, she should have proposed reforming it or scrapping it. It is not the role of the custodian of national statistics to continue producing dodgy numbers because others stand to gain financially from its inflated returns.
Placating self-interest is, ultimately, a political choice. If George Osborne wants to play statistical games to keep Tory-voting pensioners or global bond investors sweet, he should be doing his own dirty work. By doing it for him, Jil Matheson and the National Statistics Authority risk putting the integrity of their number-keeping at the gravest risk.