Price Indices Frameworks and Supporting Systems

2. Systems of Price Indices and supporting frameworks David Fenwick Director, Consumer Prices and General Inflation Division Office for National Statistics London

3. Structure of presentation • What is the problem? • Frameworks • Higher level • SNA 93 • Social Accounting matrices • Stage of Processing • Lower level • Stage of Production • Theoretical frameworks for CPIs • COLIs and COGIs • Other issues • House Price Indices • Deflators • Conclusions

4. What is the problem? • Fourfold challenge of statistical offices • Identification of user needs • Conceptualisation of user needs into economic theory • Translation of the underlying concept into statistical measurement terms (following fundamental principles of price index measurement) • Construction of indices concerned and evaluation against purpose

5. What is the problem? • Price indices serve different purposes • Definition, coverage & construction depends on purpose • What statistical offices produce is constrained by • Cost • Historical precedent • A system of price indices and supporting framework needed for • The identification of and defining in statistical terms users needs • The identification of • gaps in index provision • inappropriate applications of indices • lack of coherence & integration in indices produced • Defining future provision and work programme • Facilitating best practice (ILO resolution/UN manuals)

6. Frameworks • UN Manual (Consumer price index manual: Theory and practice) • Chapter 14 (The system of Price Statistics) • 14.8 SNA 1993- core system of value aggregates for transactions and other flows in goods and services & main price indices should have “a clear relationship” to these aggregates • 14.9 SNA contains a comprehensive framework- the supply use table- flows are defined, classified & measured in conceptually consistent manner & linkages are identified • 14.34-14.45 final consumption (definitions) - individual versus collective, social transfers in kind, acquisition versus use, monetary versus non-monetary • 14:58 supply-use tables • Other chapters (axiomatic, stochastic & economic approaches to index number theory (& practice) • ILO resolution on CPIs, 2003

7. Frameworks • Most inflation measures: • cover a small part of the supply-use table • have a narrow definition • COGI & COLI? • Population, geographical, basket of goods • Are stand alone with limited analysis of relationships • Little variety/user choice (monopoly supplier) • Very few broad measures of inflation- due in part to measurement problems (UK Final Expenditure Prices Index –FEPI) • Very little work programmed to plug the gaps

8. Frameworks • Multiple frameworks • Families are complex, multi-dimensional, inter-related • Frameworks complimentary not competitors • Higher-level • Identify gaps in family • Lower-level • Conceptual for determining detailed methodology appropriate to individual family members • Artificial distinction and simplistic • Both facilitate coherence, statistical integration, analysis

9. Frameworks: Higher-level • System of National Accounts • Basic building blocks, covers all major economic activity including: • Production, consumption & intermediate outputs • Supply use tables • Social accounting matrices (matrix representation of SNA accounts) • Flexible approach/design not standardised • Generic structure • Stage of Processing Framework

10. What Is a SAM? • A Symmetric matrix representation of economic accounts • Each account appears as a Row and a Column • Payments flow from Columns to Rows • .S Column = S row for all accounts • Can be as flexible as you wish e.g. 5 groups of accounts describing retail sector

11. Stage of Processing Framework • Divides economic process into distinct stages • Rest of World • Production (for different sectors plus primary, intermediate & final production) • Final demand (for private consumption, government consumption, capital purchases & exports • Price indices grouped according to coverage • Consumers expenditure (CPIs), other Final Demand (Index of Government Prices, Index of Investment Prices), manufacturing (PPI), trade price indices • Systematic analysis of inflationary pressures (Joel Popkin) • Identification of gaps & investigation of coherence • Economic analysis (if matrix sufficiently populated)

13. Stage of Processing Framework • Practical advantages: • Inflation rates for analysis • Aggregate “sector” price indices (& Inflation rates) can be computed for each row/column • Identification of: • Enhancements to current indices • New indices to fill gaps (value of transfers in each cell gives importance) • Issues of statistical integration & coherence

14. Stage of Processing Framework • Difficulties • Lack of relevant volume data because of differences between Stage of Processing & Input/Output matrix. • Stage of Production • assumes sector output breakdown, not available from I-O table • Gives flows from Rest of World to intermediate and final demand, I-O does not identify imports separately • Different representation of wholesale and retail distribution margins • Asset prices not covered • Ability to make practical use of information e.g.. limitations of forecasting, lack of information on retailers’ margins • Alternatives, supply-use (I-O)

15. Lower-level frameworks • Stage of Production • Supersede industry based indices • ABS development of Producer Price Indices • Commodity flows categorised sequentially according to destination in production chain following I-O approach • Final ( final consumption, capital formation, export) versus non-final commodities (intermediate consumption before further processing) • Non-final commodity flows divided between preliminary and intermediate commodities • Data demands more challenging

16. Lower-level frameworks: Stage of Production Preliminary Intermediate Final Final Stage 1 Stage 2 Stage 3 Demand Bauxite Alumina Aluminium. Export Bauxite Alumina Consumption Bauxite Capital Formation 4 stages- Bauxite is used to produce alumina which is used as an input into aluminium which is exported Alternative 5 stages- aluminium is also used to produce window frames which are then used in house production

17. Lower-level frameworks: Stage of Production • Challenges other than data • Arbitrary “Stages of production” classification • Imports (& exports) • how and if to include (also coherence in inter-country comparisons) • Practical difficulties of covering services (data deficit) • Varying time lags (how long after being mined is bauxite used at different stages) • But further de-layering represents analytical advantage e.g.. should provide stronger PPI-CPI linkage

18. Theoretical frameworks for Consumer Price Indices • Most published CPIs are not conceptually pure • Somewhere along the continuum of COLIs, COGIs & pure price indices • Historical evolution • Measurement limitations • resources • Producers/users, inertia & slow to learn • COLIs and COGIs supported by economic theory of consumer behaviour • COGI represents a sector in the Stage of Processing Framework • COLI foundation in micro-economics & theory of individual consumer behaviour • Supplement one another

19. Other price indices • House price indices • No internationally agreed conceptual framework • Confounded by different procedures for buying & selling property and data gaps • Limited statistics and meta data (cause/effect) • Priority for development

20. Indicator Macro-Economic Indicator Compensations Index (pensions, gilts etc) Deflators for National Accounts (new houses only) Housing Stock Deflator Wealth Mortgage Interest Payments Depreciation (exclude land) Transaction Weighted (£s) Quality Adjusted Transaction weighted (£s) Not Quality Adjusted Stock weighted (£s) Not Quality Adjusted Stock Weighted (£s) Quality Adjusted • Notes • 1.For depreciation and National Accounts deflators (to deflate the GFCF housing stock value) land should be excluded from the acquisition value. • 2. Land should also be excluded from a macro-economic indicator restricted to household consumption. • 3. A calculation of mortgage interest payments would require the use of a number of historical indices to estimate mortgage outlay at time of purchase and should include separate information on re-financing. • 4. Only basic house price indices are covered in this table, not derivatives used in subsequent calculations. For example, the UK Retail Prices Index’s treatment of owner-occupier housing costs, which is based on its historical roots in a compensation index, is essentially based on a mixture of the payments and user cost approaches although the RPI itself can be considered an acquisitions index. Under the acquisitionapproachthe total value of all goods and services delivered during a given period, whether or not they were wholly paid for during the period, is taken into account. With payments, the total payments made for goods and services during a given period, whether or not they were delivered, is taken into account. Finally, user cost (or consumption)considers the total value of all goods and services consumed during a given period. The distinction between the three approaches is particularly important for purchases financed by some form of credit, notably houses, which are acquired at a certain point of time, used over a considerable number of years, and paid for, at least partly, some time after they were acquired, possibly in a series of instalments. The RPI mortgage interest payments calculation uses a mix/quality adjusted transaction-weighted index to provide an historical profile of past houses purchases. • 5. Depreciation can be thought of as the costs of major repairs and renovations, with minor maintenance and decorating costs covered elsewhere in the index. In the UK it is priced using a smoothed house price index. • 6. The treatment of mortgage payments in a compensation index depends on what the owner-occupier is being compensated for. For example, whether the historical calculation to estimate current levels of mortgage debt should include the change in profile of houses acquired over the years. • 7. Clearly, in reality in some instances the primary calculation is unlikely to involve a single house price index. For instance, the calculation of wealth where separate price indices may be used to up-rate the prices of separate sectors of the housing stock (e.g.. apartments in Central London, detached houses in rural areas of Scotland) for subsequent summation to produce a total value for the UK.

21. Other price indices • Deflators- literature less well developed • limited attention in SNA 93 • Eurostat Handbook on Price and Volume Measures in National Accounts (useful guidance on industry by industry basis but little advice on conceptual framework other than recommending Supply-Use approach) • alternative approaches to construction can have significant impact (e.g. arithmetic versus geometric means), potential bias • Implications for use of CPIs as deflators, need for consistency between production & expenditure approaches to GDP. • SNA 93 distinguishes between volume of consumption and welfare (COLI inappropriate) but guidance ambiguous (e.g.. Fisher indices & constant supply-use tables). • SNA 93 assumes all price observations are weighted ( standard PPI practice but not CPI) • Mini-review of SNA 96 provides window of opportunity

22. Conclusions • Situation of compromise- supply of price indices limited and not always fit-for-purpose • Scope for more co-ordinated and systematic approach to index construction: • taking SNA 93 as starting point • Using available frameworks at different levels (Social Accounting matrices/Stage of Processing/Stage of Production) • Referring to available literature • SNA 93, UN Manual on CPIs (& corresponding PPI manual), Eurostat Handbook on Price & Volume measures in National Accounts • Supplemented by additional groundwork e.g.. house price indices & deflators • Facilitated by current mini-review of SNA 93(?) & expansion of chapters in UN Manuals on CPIs and PPIs.

23. Systems of Price Indices and supporting frameworks The end