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Latest Testimony before the House of Lords Economic Affairs Committee on the Use of RPI on 10 July 2018

  • 1.  Latest Testimony before the House of Lords Economic Affairs Committee on the Use of RPI on 10 July 2018

    Posted 17-07-2018 01:49
    I wanted to wait on the uncorrected transcript of the testimony of the Right Hon. Elizabeth Truss MP, Chief Secretary to HM Treasury and two other witnesses before commenting on that testimony, to make sure I didn't misquote anyone. 
    Ms. Truss says early on::"We would agree with the statistics authority that the gold standard [for an inflation measure] is CPI." (Has anyone in the UKSA actually said that in so many words?) Sir Robert Stheeman, Chief Executive, DMO, was more or less on the same wavelength, commenting: "The Government would also need to be quite clear as to their preferred method of measuring inflation in the future, because it is not just a question of CPI. CPIH has also been mentioned." The third witness, Steve Farrington, Deputy Director, HM Treasury, didn't endorse either of these options to replace RPI for indexing gilts or for its other roles, but he didn't care to expand their range either, and he sometimes represents the Treasury on meetings of the inflation tripartite group.
    The discussion, regrettably, was solely concerned with the use of the RPI in indexing gilts and in uprating other series, including fuel duty. So it was inappropriate that only the UK HICP, a macroeconomic price index, and the CPIH, the UK HICP with incongruous imputed rent and council tax components tacked onto it, were considered as replacements for the RPI. Since the RPI is a household-oriented index, the witnesses' testimony should have related to the Household Cost Indices and the RPIJ in the short term, and the Household Inflation Index in the long term.
    When Ms. Truss was asked by Lord Kerr if the government intended to move on fuel duty she was evasive, invoking budget secrecy. Lord Kerr must know about that as well as anyone. However, surely when the Government claims that the RPI overstates inflation by 0.7 to 1.0 percentage points it is reasonable to ask if they are going to uprate that and other duties by another index as part of some future budget, and what it might be.
    I noticed that Lord Kerr read verbatim the passage from Governor Carney's January testimony about Canada's experience changing the index used for Government of Canada index-linked bonds. Pace Governor Carney, there was no 10-year transition period. The switchover from a 1992=100 to a 2002=100 series took place all on one day, June 19, 2007. Surely a switchover from indexing gilts based on RPI to a better index, likely RPIJ, could similarly take place all on one day, no later than March 2019. Mr Stheeman worried about the consequences of a rapid switchover on Treasury sales of gilts. As Baroness Bowles said: "[I]f you only think about the immediate cost to taxpayers, the cost to society of citizens losing faith in indices is discounted."
    Since the Treasury Department and the Bank of England both seem to be joining in the pile-on against the RPI and RPI-related series, it was good to be reminded by Mr. Farrington of the existence of the inflation tripartite group. If the RPI still has so many problems (e.g. a target population that excludes many households), surely both the Bank of England and the Treasury Department bear some of the responsibility that these problems were never corrected. Erwin Diewert's report recommended six years ago that the RPI's target population be expanded, but this was never done. Surely the natural reaction when you discover a problem in a published index is to correct the problem, not abolish the index.



  • 2.  RE: Latest Testimony before the House of Lords Economic Affairs Committee on the Use of RPI on 10 July 2018

    Posted 17-07-2018 10:10

    Another issue that arises from last week's evidence session.

     

    Lord Turnbull as part of question 39, page 12 is reported as saying the following –

     

    "Lord Turnbull: Chief Secretary, you downplayed the view that there was a public trust problem. There are two areas of concern that diminish public trust. One is the inherent feature of parts of the RPI where, if a price goes up in one period and goes back to the same level it was at, or down and then back to the same level it was at, it is not calculated as zero change. That is a serious statistical flaw."

     

    In response, the Chief Secretary stated: "I agree with you about the statistical imperfections of RPI" which suggests a basic lack of understanding in the Treasury about RPI methodology.

     

    This widely held misconception quoted by Lord Turnbull probably arises because of a misunderstanding of the mathematics of Carli which does not define an index only a method of averaging price relatives.  Carli is implemented in the RPI only as a direct index and is not chain linked so does not cause the problem raised by Lord Turnbull.

     

    To be pedantic the error is to associate the problem uniquely with the RPI.  The problem that Lord Turnbull identifies can occur in all UK indices – RPI, CPI and CPIH.   This is because all UK indices fail the transitivity test because they all use a Laspeyres-type formula which is another arithmetic average – see, for example, the Johnson Review page 142.  Professor Balk also provides more background on this issue for the HICP and by implication the CPI in his paper "Mixed-Form Indices: A Study of Their Properties".  If failure of the transitivity test proved to be a significant problem in practice then it could be resolved by changing the chain linking algorithm to one compatible with an arithmetic average.

     

    The ONS article "Shortcomings of the Retail Prices Index as a measure of inflation" which has a forward by the National Statistician does not include the problem raised by Lord Turnbull as one of the shortcomings of the RPI. The ONS article was potentially misleading though because it failed to mention that all UK indices fail the transitivity test.  Such highly selective use of evidence is not helpful in ensuring that the Committee or the Treasury have a correct understanding of RPI methodology.  The article also formed the background to the National Statistician's presentation at the RSS meeting on the 13th July.

     

    Hopefully the National Statistician will be given an opportunity to correct this misconception in his evidence to the Committee this afternoon.

     

    All the best.

     

    Arthur