The RPI may not measure `real' inflation. It doesn't really matter

the problems of price indices

One of the complications the Bank of England's Monetary Policy Committee faces as it ponders, yesterday and today, what to do with interest rates, is the question of how good a guide the published inflation figures are to "true" inflation. For there is quite a vogue for arguing that the published retail price index, even on the target measure excluding mortgage interest payments, shows inflation to be higher than it really is.

This is in principle distinct from the argument that the economy has entered a new era of permanently low inflation because of a revolutionary improvement in productivity thanks to new computer technology. As Gavyn Davies demonstrated in his column earlier this week, this is a questionable assertion, as low inflation in recent years can be fully explained by low growth.

But in practice, the "new era" school of thought shores up its optimism with the idea that inflation is even lower than it appears to be, because of upward biases in the price indices. The link is that one of these biases in price measurement is the omission of rapidly falling computer prices and quality improvements.

The notion of serious mis-measurement stems from the report last year of the Boskin Commission in the US. Its economists concluded that true US inflation might be as much as a full percentage point or more below the official figure. There were several reasons for this.

One was that the index was not constructed using the lower prices charged in new kinds of retail outlets, mainly discount warehouse clubs. Nor did it include new products, like computers and other electronic goods, whose prices were falling. Nor did it take account of quality improvements that delivered better value for the same price. It missed the fact that people switch away from goods whose prices are rising too rapidly - for example, they buy chicken if fish becomes too dear. In addition, the commission criticised the formula used to construct the US consumer price index.

These conclusions proved controversial, and the US has not decided to implement them all. Meanwhile, the Office for National Statistics here has just published an assessment of how far the Boskin points apply to our Retail Price Index. The conclusion is: not very much. The RPI is based on a different formula. The UK does not have many discount clubs.

Just as important, the goods included in the RPI and the weights attached to them are updated every year on the basis of a survey of family spending patterns carried out the previous year, whereas the basket of goods in the US CPI has been updated only once a decade.

This year's RPI basket is based on 1995/96 spending patterns. The ONS has looked back at how different measured inflation would have been if the updating had been even faster. During recent years they found it to be only 0.06 to 0.07 percentage points, less than half the bias in the US figures the Boskin Commission attributed to this source.

This will not necessarily satisfy those who think the RPI overstates inflation and therefore makes the Bank reach for the interest rate trigger too early. For the index excludes some of the goods which are seeing the fastest price falls and biggest quality improvements - computers. The reason is that measuring their price and quality has simply been too difficult.

However, the ONS has started publishing a separate price index designed to be compatible with how inflation is measured in the rest of the European Union. This figure, the "harmonised index of consumer prices" or HICP, includes computers and, almost as troublesome because of their rapidly improving quality, new cars. As the chart shows, for the duration of its short existence, inflation measured by the HICP has been significantly lower than inflation measured by the RPI.

But does this make the case that inflation is "really" low and the Bank of England has nothing to worry about? Measures of price changes are needed for different purposes. To uprate social security benefits, for instance, an index which includes computers would probably be inappropriate, as the poorest families and pensioners buy very few of them. The Bank's interest in inflation is as an indicator of whether or not the economy is growing at a sustainable pace. Slow and steady inflation is essential as a solid platform for growth and jobs.

In a sense, therefore, it does not matter exactly which measure of inflation the Bank uses, for all tend to show the same broad trends. For month- to-month monitoring it is better to use figures that the statisticians can construct fairly promptly. The Government's target RPI measure excludes mortgage payments for the special reason that raising interest rates to help reduce inflation actually increases the headline RPI via this channel. The Bank itself would prefer also to exclude tax-related price changes on the grounds that these contain no information about the state of the economy.

But, broadly speaking, these three - the RPI, RPIX and RPIY - tend to show the same trends. The broader GDP deflator shows lower inflation because it includes import prices. The narrower producer price series shows lower inflation because it excludes retail margins. But any one of these would be suitable as a target measure. The key decision is setting the level of the target; and there is no convincing evidence that RPI growth of 2.5 per cent is incompatible with steady, sustainable growth and employment.

The Bank cannot entirely ignore the "new era" arguments. Technological change is making it harder to understand which prices matter. Should the ONS be measuring the price of books bought at a discount over the Internet? How can a conventional price index take account of the fact that a lot of computer software is free?

These will become more important issues over time. But there is nothing here that changes the kind of calculations the Monetary Policy Committee should be making this morning - nothing to persuade its members to relax about inflation.

News
Emma Watson has become the latest target of the 4Chan nude hacking scandal
peopleThreats follows actress' speech on feminism and equality at the UN
Life and Style
food + drink
Arts and Entertainment
British actor Idris Elba is also a DJ and rapper who played Ibiza last summer
film
Life and Style
tech
PROMOTED VIDEO
Arts and Entertainment
Geena Davis, founder and chair of the Geena Davis Institute on Gender in Media
tv
News
Alan Bennett criticised the lack of fairness in British society encapsulated by the private school system
peopleBut he does like Stewart Lee
Sport
John Terry, Frank Lampard
footballChelsea captain sends signed shirt to fan whose mum had died
Arts and Entertainment
Rita Ora will replace Kylie Minogue as a judge on The Voice 2015
tv
Life and Style
tech
Life and Style
Alan Turing, who was convicted of gross indecency in 1952, was granted a royal pardon last year
life
News
ebooksAn unforgettable anthology of contemporary reportage
Arts and Entertainment
Sheridan Smith as Cilla Black and Ed Stoppard as her manager Brian Epstein
tvCilla Episode 2 review: Grit under the glamour in part two of biopic series starring Sheridan Smith
Life and Style
life
Arts and Entertainment
Tennis player Andy Murray's mum Judy has been paired with Anton du Beke for Strictly Come Dancing. 'I'm absolutely delighted,' she said.
tvJudy Murray 'struggling' to let Anton Du Beke take control on Strictly
Life and Style
Vote with your wallet: the app can help shoppers feel more informed about items on sale
lifeNew app reveals political leanings of food companies
Sport
David Moyes and Louis van Gaal
football
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

IT Project manager - Web E-commerce

£65000 Per Annum Benefits + bonus: Clearwater People Solutions Ltd: If you are...

Trainee / Experienced Recruitment Consultants

£20000 - £25000 per annum + OTE £40,000: SThree: SThree are a global FTSE 250 ...

Trainee Recruitment Consultant - Soho

£20000 - £25000 per annum + OTE £40000: SThree: As a Recruitment Consultant, y...

Trainee Recruitment Consultants - Banking & Finance

£20000 - £25000 per annum + OTE £40,000: SThree: SThree Group have been well e...

Day In a Page

Secret politics of the weekly shop

The politics of the weekly shop

New app reveals political leanings of food companies
Beam me up, Scottie!

Beam me up, Scottie!

Celebrity Trekkies from Alex Salmond to Barack Obama
Beware Wet Paint: The ICA's latest ambitious exhibition

Beware Wet Paint

The ICA's latest ambitious exhibition
Pink Floyd have produced some of rock's greatest ever album covers

Pink Floyd have produced some of rock's greatest ever album covers

Can 'The Endless River' carry on the tradition?
Sanctuary for the suicidal

Sanctuary for the suicidal

One mother's story of how London charity Maytree helped her son with his depression
A roller-coaster tale from the 'voice of a generation'

Not That Kind of Girl:

A roller-coaster tale from 'voice of a generation' Lena Dunham
London is not bedlam or a cradle of vice. In fact it, as much as anywhere, deserves independence

London is not bedlam or a cradle of vice

In fact it, as much as anywhere, deserves independence
Vivienne Westwood 'didn’t want' relationship with Malcolm McLaren

Vivienne Westwood 'didn’t want' relationship with McLaren

Designer 'felt pressured' into going out with Sex Pistols manager
Jourdan Dunn: Model mother

Model mother

Jordan Dunn became one of the best-paid models in the world
Apple still coolest brand – despite U2 PR disaster

Apple still the coolest brand

Despite PR disaster of free U2 album
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits