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
people'It can last and it's terrifying'
Sport
Danny Welbeck's Manchester United future is in doubt
footballGunners confirm signing from Manchester United
Sport
footballStriker has moved on loan for the remainder of the season
Sport
footballFeaturing Bart Simpson
PROMOTED VIDEO
New Articles
Olivia Colman topped the list of the 30 most influential females in broadcasting
tv
News
Kelly Brook
peopleA spokesperson said the support group was 'extremely disappointed'
News
The five geckos were launched into space to find out about the effects of weightlessness on the creatures’ sex lives
i100
Life and Style
techIf those brochure kitchens look a little too perfect to be true, well, that’s probably because they are
Sport
Andy Murray celebrates a shot while playing Jo-Wilfried Tsonga
TennisWin sets up blockbuster US Open quarter-final against Djokovic
Arts and Entertainment
Hare’s a riddle: Kit Williams with the treasure linked to Masquerade
booksRiddling trilogy could net you $3m
Arts and Entertainment
Alex Kapranos of Franz Ferdinand performs live
music Pro-independence show to take place four days before vote
News
ebooksAn unforgettable anthology of contemporary reportage
News
news Video - hailed as 'most original' since Benedict Cumberbatch's
News
i100
Life and Style
The longer David Sedaris had his Fitbit, the further afield his walks took him through the West Sussex countryside
lifeDavid Sedaris: What I learnt from my fitness tracker about the world
Arts and Entertainment
Word master: Self holds up a copy of his novel ‘Umbrella’
booksUnlike 'talented mediocrity' George Orwell, you must approach this writer dictionary in hand
News
i100
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

SQL Implementation Consultant (VB,C#, SQL, Java, Eclipse, integ

£40000 - £50000 per annum + benefits+bonus+package: Harrington Starr: SQL Impl...

Head of IT (Windows, Server, VMware, SAN, Fidessa, Equities)

£85000 per annum: Harrington Starr: Head of IT (Windows, Server, VMware, SAN, ...

Technical Software Consultant (Excel, VBA, SQL, JAVA, Oracle)

£40000 - £50000 per annum: Harrington Starr: You will not be expected to hav...

SQL DBA/Developer

£500 per day: Harrington Starr: SQL DBA/Developer SQL, C#, VBA, Data Warehousi...

Day In a Page

'I’ll tell you what I would not serve - lamb and potatoes': US ambassador hits out at stodgy British food served at diplomatic dinners

'I’ll tell you what I would not serve - lamb and potatoes'

US ambassador hits out at stodgy British food
Radio Times female powerlist: A 'revolution' in TV gender roles

A 'revolution' in TV gender roles

Inside the Radio Times female powerlist
Endgame: James Frey's literary treasure hunt

James Frey's literary treasure hunt

Riddling trilogy could net you $3m
Fitbit: Because the tingle feels so good

Fitbit: Because the tingle feels so good

What David Sedaris learnt about the world from his fitness tracker
Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Saudis risk new Muslim division with proposal to move Mohamed’s tomb

Second-holiest site in Islam attracts millions of pilgrims each year
Alexander Fury: The designer names to look for at fashion week this season

The big names to look for this fashion week

This week, designers begin to show their spring 2015 collections in New York
Will Self: 'I like Orwell's writing as much as the next talented mediocrity'

'I like Orwell's writing as much as the next talented mediocrity'

Will Self takes aim at Orwell's rules for writing plain English
Meet Afghanistan's middle-class paint-ballers

Meet Afghanistan's middle-class paint-ballers

Toy guns proving a popular diversion in a country flooded with the real thing
Al Pacino wows Venice

Al Pacino wows Venice

Ham among the brilliance as actor premieres two films at festival
Neil Lawson Baker interview: ‘I’ve gained so much from art. It’s only right to give something back’.

Neil Lawson Baker interview

‘I’ve gained so much from art. It’s only right to give something back’.
The other Mugabe who is lining up for the Zimbabwean presidency

The other Mugabe who is lining up for the Zimbabwean presidency

Wife of President Robert Mugabe appears to have her sights set on succeeding her husband
The model of a gadget launch: Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed

The model for a gadget launch

Cultivate an atmosphere of mystery and excitement to sell stuff people didn't realise they needed
Alice Roberts: She's done pretty well, for a boffin without a beard

She's done pretty well, for a boffin without a beard

Alice Roberts talks about her new book on evolution - and why her early TV work drew flak from (mostly male) colleagues
Get well soon, Joan Rivers - an inspiration, whether she likes it or not

Get well soon, Joan Rivers

She is awful. But she's also wonderful, not in spite of but because of the fact she's forever saying appalling things, argues Ellen E Jones
Doctor Who Into the Dalek review: A classic sci-fi adventure with all the spectacle of a blockbuster

A fresh take on an old foe

Doctor Who Into the Dalek more than compensated for last week's nonsensical offering