I suspect that Anne's and Gareth's contributions both illustrate the folly of making long term decisions in times of more than usual economic upheaval and uncertainty. For example, if the current low growth continues for many years then indexation by the CPI is likely to appear advantageous if unsustainable.
I think though that the argument for an uprating index based on prices rather than incomes is an argument about filling a gap in the indicators. That argument is arguably different from the political argument of which index should be used for which purposes. Government can choose to use which index it thinks appropriate in the prevailing economic and political circumstances of the time.
An uprating index based on prices will provide another perspective on what is happening in the economy and help inform the debate on such issues as indexation - well that is my hope anyway. Arthur.
An uprating index based on prices will provide another perspective on what is happening in the economy and help inform the debate on such issues as indexation - well that is my hope anyway. Arthur. ------------------------------------------- Original Message: Sent: 01-07-2013 05:51 From: Anne Harrison Subject: The need for an uprating index Back in the mists of time, civil service pensions were not indexed. HMG agreed that this should change and proposed to uprate them in line with average earnings. The unions were outraged - it was a time of pay freezes and high inflation - and won their battle to have the uprating changed to the RPI. I remember this every month when my civil service pension arrives! Anne ------------------------------------------- Original Message: Sent: 29-06-2013 10:50 From: Gareth Jones Subject: The need for an uprating index It is not clear to me why people are assuming that wages, pensions and benefits should be uprated in such a way as to maintain their purchasing power in absolute terms. I would have thought that they should be uprated in such a way as to maintain their relative purchasing power compared with the national average. This would imply use of an index of average earnings rather than a price index. Wages will tend to follow average earnings automatically. If receipients of pensions and benefits are only linked to prices their incomes will not reflect economic growth and they will fall progressively further and further behind the working population. Ultimately this becomes unsustainable. But why let it get to that position in the first place? GJ ----------------------------------- Original Message: Sent: 21-06-2013 10:51 From: Jill Leyland Subject: The need for an uprating index An issue I have been thinking about for a while is the distinction I believe exists between a consumer price index designed for uprating purposes and one for macroeconomic purposes. I attach a paper on the subject. This is intended as a think piece that will, I hope, stimulate debate, not as anything definitive. Comments are welcome!
My view on using the "same aggregation formulae" for indices differs from yours and possibly Gareth's.
I am reluctant to support statistics that potentially hide uncertainty and give the impression that statistical methodology is better than it is.
The formulae conventionally used all have their problems and therefore provide one of the dimensions of the uncertainty associated with price indices.
I am a little wary to offer simple illustrative examples as they can be over interpreted but hopefully the attached spreadsheet might be useful.
The examples are simplistic and far removed from the real world but hopefully illustrate a couple of points.
What the examples do not do, and are not intended to do, is to suggest Carli is superior to Jevons or vice versa. The intention is just to offer another illustration from a layman's perspective that both produce questionable results in different circumstances.
Basically the examples I have chosen show what can happen to arithmetic and geometric means of price relatives with symmetric additive changes in prices. I would argue that a layman would reasonably consider that these symmetric changes in price to cancel each other out and that "inflation" is unchanged because the aggregate cost of the two items remains the same in both time periods.
The simplest example is the top left hand one.
In this case there are 2 items A and B each with a price of £1 at time T1. The price of A decreases by 50p and B increases by 50p at time T2. Therefore the cost of the two items remains at £2 in total at time T2 the same as at T1.
The arithmetic mean of the price relatives is 1 which indicates no price change whereas the geometric mean is 0.87 indicating a fall in price which is arguably counter intuitive.
The other two examples on the left hand side vary the price of one of the items at T1 to £2. These examples show that the two averages can both imply consistent increases or decreases in "inflation". Again I would argue that the layman would again expect no change in "inflation" with these examples.
The first 3 examples illustrate how both means can give undesirable results. (As an aside the numbers can easily be changed so that the geometric mean returns a mean price relative of 1 - change the initial value of B to 50p in the third example.)
Now it can be argued that the price changes of 50p are untypically large as they equate to things like sale prices or two for one offers. The calculations to the right show what happens when the price change is reduced. The patterns remain the same but differences reduce. By the time the price change reduces to 1p there is very little difference in practice between all the calculations of averages.
These additional calculations illustrate that although there may be theoretical problems with both methodologies they may not always represent problems in practice depending upon the data. (As a further aside not all possible simple aggregation formulae will be produce undesirable results with these examples but such formulae are likely to demonstrate problems in other circumstances.)
And finally this brings me to a more general point. One of my concerns with price index methodology is the mathematics and the way it is used. With my use of simple examples I am potentially guilty of generalising from the particular but I hope that I have made it clear that that was not my intention. In general it seems to me that proponents of different methodologies are prone to selecting particular isolated mathematical results to support their case. In their defence it may be because there is no comprehensive body of supporting mathematics to describe how different functions will behave in different circumstances, or the mathematics exists but in practice is too difficult to access.
This is not to imply that mathematics has the answers which it clearly does not because the judgement of various disciplines is likely to dominate in describing such complex phenomena. However those judgements need to be based on a sound mathematical foundation.
Arthur ------------------------------------------- Original Message: Sent: 21-06-2013 10:51 From: Jill Leyland Subject: The need for an uprating index An issue I have been thinking about for a while is the distinction I believe exists between a consumer price index designed for uprating purposes and one for macroeconomic purposes. I attach a paper on the subject. This is intended as a think piece that will, I hope, stimulate debate, not as anything definitive. Comments are welcome!
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