A convenient untruth

1. A convenient untruth Why CPI is stealing your pension

2. CPI - a huge issue • The Government has chosen to use CPI rather than RPI to increase all state pensions, state welfare payments and all pubic sector pensions • Many private sector scheme will also choose to use CPI if they can • It will affect the young even more than the old since the effect will continue relentlessly • Taken together this may affect 40% of the population very seriously

3. What’s the difference: CPI vs RPI • The Government says the main difference is CPI does not cover housing costs and Council Tax • They say it is thus more appropriate to pensioners • In fact that is NOT the main difference – there has been no rise in housing and Council tax in the last year yet the indexes are 1.2% different in Dec 2010. • Most of the difference is the way they are calculated – RPI uses arithmetic mean (AM) to average the price rises in the basket and CPI uses geometric mean (GM) • GM is always less for the same set of price rises – this is called “the formula effect” • The difference due to this formula effect has averaged about 0.75% over the last year.

4. Arithmetic Mean vs Geometric Mean • In arithmetic mean (AM) you add up the price changes in a month and divide by the number of items – it is what you would normall consider to be an average • In geometric mean (GM) you multiply the price changes together and take the nth root • GM is normally used where several change are accumulated e.g. a business grows by 2% year 1, 3% year 2 and 4% year 3. The average growth is not (2+3+4)/3 = 3 it is cube root (2X3X4) = 2.88 • But price rises across a month are not like this so GM is the wrong average to use

5. “Justification” for using GM • Statisticians say RPI overeggs inflation because it doesn’t take account of substitution • Substitution is the idea that people shift to cheaper goods and cheaper shops as prices rise • Example iceberg lettuce price stays the same and romaine price doubles. Consumers shift rorm romaine to iceberg • GM would apply (apparently) if the amount they now spend on each is equal • This argument is weak because • Iceberg not as good as romaine so quality not like for lik • Consumers unlikely to make the right calculations • Index basket is periodically adjusted which would include substitution so this is double counting • GM does not actually measure substitution at all – it is just being used as an estimate because it is just lower than AM • Basically the use of GM is a statistical fix

6. Why does index discrepancy vary • The Royal Statistical Society has estimate that the calculation method accounted for between 0.43% and 0.83% of the CPI/RPI difference last year i.e. most of it • The difference in the methods rises when the range in the individual price rises of items in the basket is greater. Some simple examples: • Item rises 2%, 3%, 4% AM=3 GM= 2.88 1%, 3%, 5% AM =3GM=2.47 1.5%,3%,4.5% AM=3 GM=2.73

7. Inconsistency • Although CPI will be used for pensioners and welfare payments it is not being used for many other things such as • The fuel accelerator tax • Index-linked gilts • The electricity feed-in tariff • The government therefore knows this is not a good measure of inflation but chooses conveniently to ignore it • All EU governments have CPI, originally designed as a comparison measure, but all the others use an RPI like measure for pension increases

8. CPI was never meant to be real index • CPI started life as an invention of the EU to enable comparison between EU economies • It was originally called the Harmonised Consumer Index of Prices (HCIP) • It excluded housing costs because these were often out of synch and excluded Council Tax because many other country lacked such a tax • Why Geometric Mean was chosen is not clear other than the questionable substitution theory • No other European country uses CPI to index pensions – they use RPI equivalents • This is clearly opportunistic thievery by the government

9. The Disastrous Cumulative effect • Over 10 years 7-10% of pension lost • Over 20 year 13- 20% of pension lost • Person now aged 20 – 30-40% lost by retirement • In the long term represents a huge reduction in pensions – the 20 year old will have an average salary pension so his pension will be 30% of current pensions • Future pensioner poverty • Burden on welfare - which will also be reduced • This is much bigger issue for the young than university tuition fees – it’s a double whammy for the young

10. Triple Lock • Government may argue triple lock on pensions – greater of CPI, wages, 2.5% • For the forseeable future wages will lag CPI (and certainly RPI) • There is no triple lock for pubic sector and private sector pensions affected – they will relentlessly fall behind inflation and wages

11. Just like the banks • Banks made money out of sub-prime mortgages by making the system so complicated it fooled people • If you make it complicated you can get away with murder – or at least theft • The Government is doing the same thing

12. The media • Have ignored this issue – probably because journalists cannot count • BBC in particular have accepted the governments ruse and now only refer to CPI “the government’s preferred measure” –rarely even mention RPI • Like sub-prime mortgages it is amazingly easy, with our media, to perpetrate such a fraud

13. Royal Statistical Society and UKSA • The RSS has written to UK Statistics Authority (ONS) to complain that CPI should include housing costs and Council Tax and that the calculation method is producing to great a discrepancy • Here is a good article on the topic http://www.straightstatistics.org/article/rpi-vs-cpi-seconds-out-round-two • Here is the RSS letterhttp://www.nfop.org.uk/docs/RSS%20re%20RPI%20CPI.pdf

14. CPI + • UK Statistics Authority working through Consumer Prices Advisory Committee (CPAC) to include housing costs and Council Tax • If they do this it will be embarrassing because will become obvious that the difference is the calculation method • It will be obvious that the government has been lying or ignorant – take your pick