On the issue of changing the RPI measure, the interests of a politically potent minority trump those of the silent majority
A classic British fudge. That's the only way to describe the
unexpected decision by Jil Matheson, the national statistician, to
continue using what she admits is a flawed measure of inflation as the
benchmark for pensions, rail fares, government borrowing costs and a
whole range of other prices.
The announcement is a victory for pensioners, who have lobbied vigorously against any change that would affect the returns on index-linked pensions, but it is not such good news for George Osborne and millions of other consumers. As is often the case, the interests of a sizeable,
vociferous and politically potent minority have trumped those of the silent majority.
Here's what has happened: Britain has two main measures of inflation – the retail prices index and the consumer prices index. The RPI is the older of the two and dates to 1914. It uses what is considered an outdated methodology to calculate price pressures in the economy, but is still widely used as the benchmark for index-linked gilts and bonds, and for many annual pay deals.
In recent years, the CPI has been considered a more robust measure of inflation. It uses an internationally agreed formula and is the yardstick against which the Bank of England is judged when given the task by the government of hitting a 2% inflation target.
There is a sizeable difference – of about a percentage point – between the higher RPI measure of inflation and the lower CPI measure, and the chancellor has saved the Treasury billions of pounds by switching the uprating of many state benefits from the RPI to the CPI.
Last autumn, the Office for National Statistics announced an RPI consultation process and provided four options, one of which was to stick with the status quo. The ONS's advisory committee urged change and on Thursday Matheson accepted the current method of calculating the RPI does not pass muster. So far, so simple. This was precisely what was expected.
What was not expected was that Matheson would go on to say that the RPI would continue in existence, calculated in the old way, but that a new measure of RPI, based on the Jevons formula used for the CPI, would be created. This will be called RPIJ, and will be given greater prominence than the bog-standard RPI when the ONS releases the monthly inflation statistics.
Michael Saunders, UK analyst at Citibank, noted drily that Britain is spoilt for choice when it comes to ways of calculating the cost of living. "With RPIJ, the UK will now have eight monthly consumer inflation measures (CPI, CPIY, CPI-CT, RPI, RPIX, RPIY, TPI and the new RPIJ), while this will rise to nine with the upcoming CPIH measure." Confused? You should be.
The ONS view is clearly that the RPIJ is a superior measure and that it is up to the government to decide which it uses, since that is a political decision that should be taken by MPs.
The potential savings for the Treasury of no longer using the RPI were considerable. Capital Economics estimate that lower borrowing costs could have saved the exchequer £7bn a year by 2016-17. Businesses that pay RPI-linked rates, rail passengers who have their fares uprated each year using the RPI, and pension funds, whose future liabilities would have been lower, also lose.
There were two big arguments in favour of sticking with the status quo. The first is consistency, a point made by Mike Amey, Pimco managing director. "The sterling index-linked market is a long-established market with what had been a clear set of rules", he said. "Changing those rules would have risked a structurally higher risk premium across all UK bonds, thereby negating the short-term gain to the Treasury from any lower payments on existing index-linked gilts."
The second argument was political. Pensioners are already unhappy about the impact of quantitative easing, which by driving down bond yields has led to lower annuity rates. Switching to the RPIJ would have been cleaner, simpler and less confusing. But it would have meant a fight with pensioners, something ministers would prefer to avoid. For now, at least.
The announcement is a victory for pensioners, who have lobbied vigorously against any change that would affect the returns on index-linked pensions, but it is not such good news for George Osborne and millions of other consumers. As is often the case, the interests of a sizeable,
vociferous and politically potent minority have trumped those of the silent majority.
Here's what has happened: Britain has two main measures of inflation – the retail prices index and the consumer prices index. The RPI is the older of the two and dates to 1914. It uses what is considered an outdated methodology to calculate price pressures in the economy, but is still widely used as the benchmark for index-linked gilts and bonds, and for many annual pay deals.
In recent years, the CPI has been considered a more robust measure of inflation. It uses an internationally agreed formula and is the yardstick against which the Bank of England is judged when given the task by the government of hitting a 2% inflation target.
There is a sizeable difference – of about a percentage point – between the higher RPI measure of inflation and the lower CPI measure, and the chancellor has saved the Treasury billions of pounds by switching the uprating of many state benefits from the RPI to the CPI.
Last autumn, the Office for National Statistics announced an RPI consultation process and provided four options, one of which was to stick with the status quo. The ONS's advisory committee urged change and on Thursday Matheson accepted the current method of calculating the RPI does not pass muster. So far, so simple. This was precisely what was expected.
What was not expected was that Matheson would go on to say that the RPI would continue in existence, calculated in the old way, but that a new measure of RPI, based on the Jevons formula used for the CPI, would be created. This will be called RPIJ, and will be given greater prominence than the bog-standard RPI when the ONS releases the monthly inflation statistics.
Michael Saunders, UK analyst at Citibank, noted drily that Britain is spoilt for choice when it comes to ways of calculating the cost of living. "With RPIJ, the UK will now have eight monthly consumer inflation measures (CPI, CPIY, CPI-CT, RPI, RPIX, RPIY, TPI and the new RPIJ), while this will rise to nine with the upcoming CPIH measure." Confused? You should be.
The ONS view is clearly that the RPIJ is a superior measure and that it is up to the government to decide which it uses, since that is a political decision that should be taken by MPs.
The potential savings for the Treasury of no longer using the RPI were considerable. Capital Economics estimate that lower borrowing costs could have saved the exchequer £7bn a year by 2016-17. Businesses that pay RPI-linked rates, rail passengers who have their fares uprated each year using the RPI, and pension funds, whose future liabilities would have been lower, also lose.
There were two big arguments in favour of sticking with the status quo. The first is consistency, a point made by Mike Amey, Pimco managing director. "The sterling index-linked market is a long-established market with what had been a clear set of rules", he said. "Changing those rules would have risked a structurally higher risk premium across all UK bonds, thereby negating the short-term gain to the Treasury from any lower payments on existing index-linked gilts."
The second argument was political. Pensioners are already unhappy about the impact of quantitative easing, which by driving down bond yields has led to lower annuity rates. Switching to the RPIJ would have been cleaner, simpler and less confusing. But it would have meant a fight with pensioners, something ministers would prefer to avoid. For now, at least.
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