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RPI versus CPI

An economic perspective

27 June 2017
Introduction

 Inflation is the tendency for prices to rise over time.
 The inflation rate measures the pace at which prices rise.
 It is calculated by looking at changes in the individual prices of a sample of goods
and services: ‘the basket of goods’.
 Different measures of inflation include different sets of goods and different
approaches to aggregating individual price movements into a headline inflation
rates.

Source: Aylward (2016), KPMG.
Inflation and the cost of living

 Inflation rates measure changes in prices, not in the cost of living.
 Cost of living is an ‘ill defined’ concept (ONS, 2014).
 Changing the basket of goods underpinning inflation rates will not directly impact the
inflation rate.
 Changing perceptions about what constitutes a ‘basic’, ‘minimum’ or ‘constant’
standard of living will affect the perceived cost of living.
 The cost of living is measured in currency, whereas inflation is measured in percent.
 Increases in cost of living may be higher or lower than the inflation rate.

Source: Aylward (2016), KPMG.
RPI and CPI: different histories

 RPI descends from the ‘Cost of Living Index’, first published in 1914.
 Significant changes were made following the Second World War, and the modern
RPI was first published in 1956.
 CPI was introduced in 1997, as the EU established a consistent approach to
measuring inflation: the Harmonised Index of Consumer Prices.
 CPI was adopted by Bank of England in 2003, and by the Government for the
indexation of benefits, tax credits and public sector pensions in 2010.
 RPI stripped of National Statistic Status in 2013.

Source: Aylward (2016), KPMG.
RPI and CPI: different people

 The CPI basket is based upon consumption recorded in the National
Accounts, and therefore includes:
 spending in the UK by foreign visitors;
 institutional households, such as university halls and hospitals; and
 the entire income distribution.
 Weights are updated in two stages in January and February each year.
 The RPI basket is based on the Living Costs and Foods Survey, and
excludes:
 the top 4% of the income distribution; and
 households dependent upon state pensions.
 Weights are updated in January each year.

Source: Aylward (2016), KPMG.
RPI and CPI: different goods

 Besides the different weights (resulting from different representative
consumers), RPI and CPI cover different items.
 RPI includes a number of housing costs, including mortgage
repayments and council tax.
 RPIX is the equivalent with these excluded.
 CPIH includes Owner Occupier Housing costs.
 CPI includes university accommodation fees and foreign student
tuition fees.
 RPI only includes second hand cars.

Source: Aylward (2016), KPMG.
RPI and CPI: different formulae

 At the lowest level of aggregation, the two indices use different
approaches to averaging changes in prices of individual goods:
 RPI is based on the Carli approach, which uses an arithmetic average; whereas
 CPI is based on the Jevons approach, which uses a geometric average.
 An arithmetic average of price changes will always be higher than a
geometric average of the same price changes.
 Neither Carli (arithmetic) nor Jevons (geometric) is necessarily ‘correct’ for
a comparison of prices between two periods.
 However, when weights are recalculated, indices must be ‘chain linked,’
which can lead to inconsistencies between reported inflation and
underlying price movements with the Carli approach.

Source: Aylward (2016), KPMG.
RPI and CPI: different numbers

CPI and RPI, January 1989 = 100
RPI has been 0.7
percentage points higher, on 260

average, since 1989 than
the CPI, making a 240

cumulative difference of
nearly 20%. 220

The formula effect was 200

estimated at around 0.5
percentage points until 180

2010, but since increased.
160

The Bank of England
currently assumes it is 0.9 140

percentage points. CPI

120
RPI

100
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Source: ONS

Source: Aylward (2016), KPMG.
RPI and CPI: which is better?

Index Advantages Disadvantages
RPI  Based upon household data.  Not a cost of living measure.
 Well recognised.  Excludes some pensioners.
 Uses Carli.
 Not a national statistic.

CPI  Uses Jevons.  Not a cost of living measure.
 Includes all pensioner  Includes university accommodation
households. fees, foreign student university tuition
 Meets international standards. fees and stockbroker fees.
 Includes foreign visitors.
 Includes institutional households and
the very rich.

Source: Aylward (2016), KPMG.
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Housing

• Housing costs account for 10% of household expenditure
• From March this year, the ONS has published CPI-H as its headline rate of inflation.
• CPI-H is based on rental equivalence – the price you would have to pay to rent your
own house
Conclusions

 Differences in baskets of goods do not definitively favour RPI or CPI.
 From a mathematical perspective, it has become very difficult to argue in favour of
a Carli based approach.
 National Statistician: “Put simply, I believe that the RPI is not a good measure of
inflation and does not realistically have the potential to become one. I strongly
discourage the use of RPI for as a measure of inflation as there are far superior
alternatives.”

Source: Aylward (2016), KPMG.
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