I will add a document to the library tomorrow, "Governor Carney's Evidence on Consumer Price Indices before a Parliamentary Committee" that gives my views on the matter.
I added a comment on your January 31 blog that reads in part: "Chris Giles [of FT] was mistaken in reporting Carney as saying "most would acknowledge, [the RPI] has no merit" …. What he actually said, audible on the tape even if he is a mumbler, is: "At the moment, we have RPI, which most would acknowledge has known errors."
Far more inexplicable than Governor Carney's silence on the RPI is his silence on RPIJ, which to my knowledge has never been broken. Most of his public career, at the Bank of Canada and at the Department of Finance, he supported without a single caveat the Canadian CPI as the target inflation indicator of the Bank of Canada, an index that is very close methodologically to the RPIJ. It has much less in common with the UK CPI or the CPIH. If he really finds the accounting approach to measuring owner-occupied housing costs used in the RPI/RPIJJ lacking why did he have no problem with it in almost a decade in Canadian public life, since the Canadian CPI uses the same approach? Like everyone else, he is entitled to change his mind, but if this is what has happened he surely owes an explanation to the UK public when and why this happened.
Happy Groundhog Day! (Wiarton Willie saw his shadow so we will have at least six more weeks of winter here.)
A big thank you to Andrew for pointing out the error in Chris Giles account which prompted me to look again at the committee web site.
The Lords Committee has now published the text of Mark Carney's evidence which is easier to follow. http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/economic-affairs-committee/governor-of-the-bank-of-england-2017/oral/77776.pdf
The evidence on price indices starts on page 19 with a question from Lord Livermore.
Mark Carney's opening paragraph is recorded as follows –
"Well, there are, as you say, some known errors, acknowledged by the ONS and recognised by a number of external commentators. We would share some of those views about how the index is calculated, using the Carli method, which has an asymmetric bias, and how housing costs are implemented, as well as issues about clothing. So there are some known errors."
I won't comment further here other than to say that there are issues around all these "known errors".
All the best.
I would like to return your attention to the evidence you gave to the Select Committee on Finance of the House of Lords on the 30th of January on the Retail Price Index or RPI. This is not only because it is an important matter it itself but also it is a welcome innovation to see the Bank of England enter the debate over how to measure inflation. However I do have concerns about what you said and in particular this section.
The issue of "known errors" within the RPI is much more open to debate than you suggested and such debates have taken place at the Royal Statistical Society and it is a shame that the Bank of England has not engaged with these. It is also my understanding that its treatment of housing costs is analogous to that used by the CPI in Canada during your tenure as Governor of the Bank of Canada so are you now unhappy with the latter as well?
By contrast if we move to the Consumer Price Index or CPI which is currently used as the UK inflation target measure there is a glaring hole in the way it completely ignores the owner-occupied housing sector. I am not sure what is a step up from known error but I can say that ignoring something as important to the UK as that sector when UK house prices have risen by over 29% in your term as Governor when the targeted CPI has only risen by more like 7% is exactly that.
Perhaps worst of all is the current favourite of the Office for National Statistics the inflation measure called CPIH and that is because it uses fantasy numbers to cover the housing sector. There is an obvious problem in assuming that owner-occupiers pay rent to themselves when they do nothing of the sort. This is added to by the problems seen with the data where after what was described as somewhat euphemistically as a "discontinuity" we are on what in film industry terms is called "take two". Also my understanding is that the ONS does not have full access to UK rents data as the problems with this measure multiply.
You made no mention in your evidence of the Eurostat report that must be released before December 31, 2018 on the incorporation of an Owner Occupied or OOH component based on net acquisitions in Eurostat HICPs. If Eurostat did decide to incorporate such a component in Eurostat HICPs, it would mean, as things currently stand, that the remit of the Bank of England would be changed through the back door, as the UK CPI is just the UK HICP under another name. What is your view of Eurostat's proposed HICP reform via the use of house prices and the implications for UK inflation measurement and targeting?
Furthermore there is the issue over how your words have been reported in the media and in particular over the use of the phrase "no merit" in relation to the RPI. This was reported to my knowledge by the Financial Times and Sky News. Indeed the economics editor of the Financial Times Chris Giles has repeatedly emphasised the point across many different media forms. However the transcript which was kindly posted on the Royal Statistical Society website ( www.statsusernet.org.uk ) does not appear to contain this phrase. I would appreciate it therefore if the Bank of England would take the opportunity to put the record straight as otherwise there is the danger of misapprehension.
I await your thoughts in response.
Good luck with your letter. I am sure you will receive some kind of response. And thank you for your kind acknowledgement of the help of Arthur and myself.
As you say, the RPI's "treatment of housing costs is analogous to that used by the CPI in Canada" when Mr. Carney was the governor of the Bank of Canada (and actually for his whole public career in Canada at both the Bank of Canada and the Department of Finance). I would like to emphasize a point I made in my document "Governor Carney's Evidence on Consumer Price Indices before a Parliamentary Committee": the only important difference in scope between the two indices is that the Canadian CPI's basket includes land transfer taxes while the RPI's excludes stamp duties. Land transfer taxes are an important cost to homeowners in Canada just as stamp duties are in the UK. By coincidence they became substantially more important in Canada on February 1, 2008, the very day that Carney took office as governor, when Toronto, the largest Canadian city, introduced a municipal land transfer tax, making it the only city to have both a municipal and a provincial land transfer tax. So if Governor Carney disagrees with the treatment of OOH in the RPI, he should have disagreed even more strongly with the treatment of OOH in the Canadian CPI, since land transfer taxes are a transaction cost and a component of gross fixed capital formation.
The Bank of England for many years calculated a Housing-Adjusted Retail Prices (HARP) Index based on the opportunity cost variant of the user cost approach. As you know, Gareth jones, in our RPI CPI User Group, is a strong advocate of this approach. The HARP index excluded all transaction costs, not just stamp duties, but also estate agents' fees and conveyancing fees, quite reasonably so from the BoE's perspective, as these were all part of gross residential construction expenditures and were not part of consumption.
The rental equivalence approach and the opportunity cost variant of the user cost approach are closely related and in fact they can always be made equivalent in empirical work simply by choosing an appropriate interest rate for the opportunity cost of owner's equity. In February 1993, the BoE preferred the opportunity cost approach because "rents in the controlled private market did not provide a good guide to the rental equivalent of owner-occupied houses", but the Bank of England no longer seems to have any concerns on this subject. The rental equivalence approach has pretty much always treated transaction costs as out-of-scope wherever it has been implemented. They are not in the US CPI; neither are they included in the OOH component of the CPI.
Recently a Bank of Canada paper proposed that the Canadian CPI switch from its accounting approach to measuring OOH, which for some reason they choose to consider a truncated opportunity cost approach, to a full-fledged opportunity cost approach:
However, they have left all transaction costs in their proposed index: land transfer taxes, real estate commissions and legal fees. They are all part of the other owned accommodation expenses component. It is surely inappropriate to talk about measuring "the value of the services consumed" and be quite unfazed about including elements of gross residential construction expenditures in your measure but it doesn't seem to bother the authors of the paper so possibly it doesn't bother their former boss either.
I hope that you do not have a long wait for a response to your excellent letter.
Below are comments on a few of the issues with the section on the formula effect in the ONS article "Shortcomings of the Retail Prices Index as a measure of inflation".
These comments are for the most part based on evidence presented in previous posts on SUN.
The formula effect section is in part factually incorrect and arguably in other parts misleading in its selective use of evidence though ONS do not appear to claim that this article represents any more than their judgement.
The article is factually incorrect in associating transitivity and "price bounce" solely with the use of Carli in the RPI. This price bounce argument would apply to a chain linked Carli index and the RPI methodology doesn't use chain linked Carl. Chain linking occurs at a higher level of aggregation than the elementary aggregates in all UK price indices and therefore in addition to the RPI price bounce is a feature of CPI and CPIH which the article neglects to mention.
Much of the questionable inference in the article appears to be derived from a misinterpretation of the short quote taken from "The United Nations Practical Guide to Producing Consumer Price Indices" –
"A key result is that the Carli formula for the arithmetic average of price relatives has an upward bias relative to the trend in average item prices. In particular the Carli suffers from lack of transitivity i.e. when prices return to an earlier level the chained index doesn't. Consequently, it is a formula to be avoided and some judge that it should be prohibited."
The opening sentence of the forward of the UN guide starts with –
"This Handbook is targeted at developing countries…"
This raises the question of why ONS chose this particular methodological source. There are other international sources at Eurostat and the ILO that are more appropriate to a developed country like the UK. They offer a different set of conclusions that the article neglects to mention.
Quoting the UN guide the article refers to Carli having an "upward bias relative to the trend in average item prices". Quite what that means is not clear but on a reasonable interpretation the chart below from a SUN post of October 2014 based on analysis from the Johnson Review shows that for vacuum cleaners this statement does not hold. For this Johnson derived analysis the RPI type item index is an annual chain linked Carli unlike in the RPI methodology where Carli is only used as a direct index. However the chart shows that the UN guide statement does not even hold when the guide would expect the item index trend to be biased upwards by price bounce.
The differences in the above chart between the RPI or CPI indices and the average price index are conventionally used as an indicator of implied quality change. The Johnson Review used such differences as measures of implied quality change and commented that implied quality change can have a major influence on the indices. There were changes in the treatment of non-comparable substitutions/implied quality change in 2010 for clothing. This is likely to have resulted in a different relationship for clothing from that for vacuum cleaners shown in the above chart. The article's case against Carli places considerable importance on the behaviour of clothing since 2010 but neglects to mention this significant change in methodology.
The article is dismissive of expert contributions such as that from Mark Courtney without directly addressing the arguments. There is an associated issue here with how reliably the advice ONS receives from its advisory panels is reported as the recent SUN posts on chain linking illustrate. The article neglects to mention contributions on SUN even though recent postings would have provided the information to avoid the error on the RPI, Carli and transitivity/price bounce.
The recently published Code of Practice for Statistics v2 offers a regulatory perspective on the article.
The code includes the Quality principle Q2.1 –
Methods and processes should be based on national or international good practice, scientific principles, or established professional consensus.
The quality of the section of the article on the formula effect measured against Q2.1 would arguably fail all its requirements.
There appears to be a strong argument that unless improved this article would fail to meet the requirements of the Trustworthiness Pillar of the Code of Practice and the standards of behaviour set out in the Civil Service Code.
An explanation from ONS, perhaps?
The ONS article "Shortcomings of the Retail Prices Index as a measure of inflation" can be found at – https://www.ons.gov.uk/economy/inflationandpriceindices/articles/shortcomingsoftheretailpricesindexasameasureofinflation/2018-03-08/pdf
Thank you for your very interesting note.
I added a document to the library with my own critique on the shortcomings paper.
I didn't say anything about the discussion of the formula effect as I was more comfortable with the switch from RPI to RPIJ than you were. Still, it seemed to me the document created a misleading impression about international rejection of the Carli formula. While it was true that it was pretty much expunged from the Canadian CPI in 1978, it was and probably still is much used in Canadian producer price indices in the context of pps sampling. If pps samples were used more in the Canadian CPI (they were virtually non-existent there in 1978 and long after) the Carli formula might have been used a little more.
Thank you for your response and the very helpful document that you added to library.
I purposely confined my comments to the formula effect section and left the other sections to those like you who are better able to comment.
In general my concerns with the article are twofold.
My primary concern is less with the RPI/RPIJ than the potential implications of the article being used by ONS to restrict the methodologies available for use by the HCI. As one example, Carli should be available to use if the empirical evidence for particular products/services or the index as a whole indicates that it is an appropriate formula to use. This does not mean that the use of Carli should match its use in the RPI or any such arbitrary target. There are also additional complexities with other issues that interact with the choice of formula like quality adjustment and these may well be more important in the construction of the HCI.
The secondary concern which is related to the primary concern is whether the approach adopted in the article is appropriate. There appears to be the potential for issues with the codes under which ONS operates.
There is though one technical statistical point that your document reminded me of that I had missed. This is the index used by ONS for rental equivalence.
First a question for ONS – has the methodology article for the rental equivalence index (IPHRP) been published?
This is important given the apparent 9 month or so lag inherent in the index and the implications that has for what the index actually measures. There is also an issue given the administrative source of how stable over time the index will be in what it measures. This is more important from a household perspective than a macroeconomic perspective because macroeconomists have the tools to cope with such uncertainties but the general public does not. This highlights the issue of whether rental equivalence as implemented by ONS can be considered appropriate for a household index.
The discussion so far has already exposed the errors in the way the ONS paper, "Shortcomings of the Retail Prices Index as a measure of inflation," deals with the formula effect and how the coverage issues it highlights actually make the RPI look rather better than its favoured CPIH. A third feature of the paper is the very selective way it deals with clothing inflation, claiming that the current clothing inflation figures show that in practice (the ONS has conceded that there is no general theoretical superiority) the Jevons elementary aggregation formula is always the most appropriate. It is common ground that since 2010 the CPI clothing index has been more plausible than the RPI clothing index, just as before 2010 the RPI clothing index was more plausible than the CPI clothing index. That is because, prior to 2010, we had a huge negative sampling error for clothing, and the formula effect wedge tended to offset it in the case of the RPI and exaggerate it in the case of the CPI; whereas, post-2010 we have a huge positive sampling error for clothing, and the even larger formula effect wedge tends to offset it for the CPI and exaggerate it for the RPI. Without being able to disentangle the formula effect from the sampling error, one cannot draw any conclusions about the performance of the aggregation formulae.I've placed in the Library a paper "UK Clothing Inflation 1997-2016" (also available at ssrn.com/abstract=3140666) which examines this question in some detail. As it happens, we can use movements in the implied relative clothing volumes and the results of the ONS' 2011/12 clothing price pilot, to come up with a fair estimate of the effects of the excessively loose clothing price sampling post-2010. This shows that, with an undistorted clothing price sample, there would be much reduced formula effect wedge and that - consistent with results in other sectors - the overestimation of a target Fisher index by the RPI would be about equal to the underestimation by the CPI. And this is not a mere curiosity. By building on the 2011/12 clothing price pilot the ONS could, if it wished, improve the methodology for clothing price sampling to greatly reduce the formula effect wedge and improve the accuracy of both the RPI and CPI clothing indices.
One other issue with this ONS article is the timing of its publication – this seems rather odd and warrants explanation from ONS.
There would appear to be no obvious reason to rush the publication of the article and circumvent the usual arrangements of advisory panel meetings for the governance of consumer price indices.
The article in draft or final form did not appear on the agenda of the January meeting of the Technical Panel or the February meeting of the Stakeholder Panel although the article was published a relatively short time afterwards at the beginning of March. The timetable for publication appears rushed and arguably the article appears so too.
The assumption must be that there is nothing untoward here just something akin to an accidental and unexpected juxtaposition of events to explain the timing of the publication that ONS can provide easily and quickly.
However beyond that there is the issue of the transparency of the governance process which is missing here – users have been left very much in the dark.
Presumably in line with past practice the advice of members of both advisory panels was sought before the publication of such a potentially controversial article. If this was the case then the difficulty is that this arrangement outside of meetings of the panels is not transparent. It effectively circumvents the publication of the draft article and the meeting minutes which would contain the advice of the panels.
Given that the usual governance procedures don't appear to have been followed there is also the issue of whether or not prior to publication the article in final or draft form was shared with other groups and whether or not their advice or comments were sought or received. Such other groups may include, for example, the Tripartite/Tetrapartite Group or The Economic Experts Working Group.
There is a lack of transparency in the deliberations of both the Tripartite/Tetrapartite Group and The Economic Experts Working Group. This gives rise to a question of whether the priorities of some of the members of either of these, or other, groups may have contributed to a rushed publication of this article.
The information requested in this post relates to the governance of price indices and, for example, could be released quickly as supplementary papers for the January and February meetings of the two advisory panels.
Dear Mark Courtney:
Thank you for your very interesting paper.
If a third of clothing items in the UK consumer price sample can be considered as seasonal, as indicated on page 8 of your paper, any review of the measurement of clothing inflation should consider the options for dealing with seasonal goods. As far as I know this has never been properly done for clothing in UK consumer price indices.
The only recent study on seasonal weighting for clothing consumer price series for any European country in recent years that I am aware of is the paper presented at the Joint UNECE/ILO Meeting on Consumer Price Indices 10 – 12 May 2010, Palais des Nations, Geneva by Monica Montella and Franco Mostacci: "The impact of European Commission Regulation on the treatment of seasonality in the HICP for Italian clothing". Unfortunately, its authors were stymied by the very rigid restrictions on seasonal weighting imposed by the EC regulation on seasonal goods, and Istat did not decide to go with seasonal weighting for clothing in the Italian HICP.
In my view, linking at the year for consumer price series should be considered as an alternative to linking at December or January, which has obvious advantages when dealing with seasonal goods.
The quality adjustment problems you mention are more serious for seasonal items than for non-seasonal items.