Measurement of UK Consumer Price Inflation

1. Measurement of UK Consumer Price Inflation A presentation given to the Royal Statistical Society, January 2011 Pam Davies, Darren Morgan & Phil Gooding Office for National Statistics

2. Topics included in the presentation 1. History & Background of the CPI & RPI 2. Current Practice: coverage, approach & methods • Differences between the CPI & RPI • Uses and Users of the CPI & RPI • CPI & RPI Governance • Future CPI & RPI Work Programme • Consultation

3. 1. History & Background of the CPI & RPI

4. 1. History & Background of the CPI & RPI RPI: • ‘old lady’ of UK inflation measures • established in June 1947 although not ‘official’ until January 1956 • 1947 - 1994: improvements via recommendations from RPI Advisory Committees • 1956: population coverage established • 1962: weighting framework should be updated every year via a household budget survey • 1971: construction of regional prices feasible but costly and determined should not proceed • 1974: measurement of owner-occupied costs changed to Mortgage Interest Payments from rentals equivalence • 1995: measurement of house depreciation included • 1995 – 2008: improvements agreed via protocols between ONS (UK Statistics Authority), Bank of England & Treasury • 2004: move to hedonic regression approach to quality adjustment for certain high-tech goods • Since 2009: ConsumerPrices Advisory Committee set up to Advise the Authority on improvements • 2010: change to Average Effective Rate from Standard Variable Rate in measurement of Mortgage Interest Payments

5. 1. History & Background of the CPI & RPI CPI: • ‘new kid on the block’ - born Jan 1996; key principle international comparability & standards • standards of construction and continuous improvement via European legislation • 2000: population extended from private households to also include institutional households and visitors to the UK • 2001: hospital services and nursing and retirement homes included • 2002: financial services expressed as proportion of transaction value included • meteoric rise: • developed by EU to assess membership of the European Monetary Union • became ECB’s inflation measure to define/assess price stability in Euro area • since Dec 2003 basis for UK Government’s inflation target • from Apr 11 used in indexation of benefits, tax credits and public service pensions

6. 2. Current Practice: coverage, approach & methods

7. 2.Current Practice: coverage, approach & methods Population,Coverage & Classification

8. 2. Current Practice: coverage, approach & methods Data Collection (CPI & RPI) • 180,000 individual price quotes each month • 680 different products • 20,000 shops and service providers + the internet • 141 locations around the UK • collection from ONS rather than high street for certain products • national pricing policies • non-store collection e.g. football admission prices, domestic gas • internet shopping

9. 2. Current Practice: coverage, approach & methods Quality Assurance & Checking • exactly the same approach for CPI & RPI • each price quote subjected to different validation tests e.g. • month on month movement • variation since base period • minimum & maximum ranges • dispersion for price quotes within a particular item • each failure reviewed and decision made on acceptance or rejection • decisions on ‘comparability’ reviewed by at least two different quality assurers

10. 2. Current Practice: coverage, approach & methods Weighting, Aggregation & Rounding

11. 2. Current Practice: coverage, approach & methods Publication • Pre-release access: • CPI & RPI: 24 hours for Treasury, Bank, BIS & No. 10 • CPI: 3.5 days for MPC when meeting the week prior to publication • CPI: 5pm on Fri prior to publication (Tues) inform Bank & Treasury whether Open Letter protocol triggered • Internet publication: • headline publications (statistical bulletin, nugget) • detailed data (detailed briefing, Focus on Consumer Prices) • database for downloading data for further analysis • other ONS publications • social media • Press conferences: • wire agencies • newspapers

12. 2. Current Practice: coverage, approach & methods Annual Improvements • exactly the same approach for CPI & RPI for standard improvements: • weighting framework completely updated every year • basket of goods and services updated every year • both done to ensure CPI & RPI reflect latest household spending patterns • methodological development also implemented e.g. • 2010: improved methods for measurement of mortgage interest payments in the RPI • 2011: improved measurement method for seasonal items for CPI & RPI

13. 3. Differences between the CPI & RPI

14. Breakdown of the differences between CPI and RPI

15. Breakdown of the differences between CPI and RPI

16. Breakdown of the differences between CPI and RPI

17. Breakdown of the differences between CPI and RPI

18. 3. Main differences

19. 3. Main differences

20. 3. Main differences Index Construction Formulae • CPI • mostly geometric mean • based on European regulation • RPI • arithmetic mean • from historical rules developed under auspices of earlier Advisory Committees

21. 3. Main differences

22. 4. Uses and Users of the CPI & RPI

23. 4. Uses and Users of the CPI & RPI CPI: • macroeconomic indicator • UK Government’s official inflation target • deflation of certain economic series • international comparison and inflation measurement • used by Eurostat in calculation of European Union inflation • nearly always used when UK inflation compared to other countries • income adjustment • indexation of salaries? • indexation of pensions and benefits • price adjustment • contract escalation?

24. 4. Uses and Users of the CPI & RPI RPI: • macroeconomic indicator • inflation measure • deflation of expenditure and output • income adjustment • indexation of tax allowances • indexation of salaries • uprating redemption values of certain gilts and national savings certificates • price adjustment • contract escalation • price regulation

25. 5. CPI and RPI Governance

26. CPI Governance • European statistical system • Series of regulations • UK part of the ESS, so has influence over decisions • ONS represents UK view • UK does not have a free hand to dictate changes to CPI • Unless UK decides to pursue a national version of the CPI…

27. RPI Governance – pre 2008 • Previously managed via RPI Advisory Committee • The Committee advised the Chancellor on RPI methodological issues etc • Met only infrequently • Last met in 1994 • ‘Major’ changes considered by the RPIAC • RPI kept up to date through regular update of basket of goods and services and of weights etc

28. RPI Governance – post 2008 • Statistics and Registration Act 2007 established new arrangements • Proposed changes require approval of Statistics Authority • Authority to consult Bank over whether proposed changes are fundamental and materially detrimental to index linked gilt holders • If yes, then Authority needs Chancellor’s approval for the change • If no, then Authority can proceed with change • Authority established a group of experts to advise them – the Consumer Prices Advisory Committee (CPAC)

29. CPAC Terms of Reference 1. To advise the UK Statistics Authority on the implication for the Retail Prices Index (RPI) of the improvements to this index recommended by the Office for National Statistics (ONS). 2. To provide the UK Statistics Authority with advice on RPI methodological issues. 3. To advise the UK Statistics Authority on improvements to the UK Consumer Prices Index (CPI) recommended by the ONS.

30. The new governance framework • Enables: • RPI to be better measured through implementation of improved methods • Greater alignment of RPI and CPI methods • ONS to have access to expertise on inflation • Greater transparency on proposals for change • Clear and efficient decision making process • But: • Still not easy to make changes to the RPI

31. 6. Future CPI & RPI Work Programme

32. CPAC programme • Possible implementation in 2011 /12 • Further development of owner occupiers’ housing costs for the CPI • Measurement of rents in the CPI and RPI • Measurement of cars in the CPI and RPI

33. CPAC Programme • Possible implementation in 2012 /13 • Review / update sample selection of locations for the CPI and RPI • Review of the optimum base period in the construction of the CPI and RPI

34. CPAC Programme • Possible implementation in 2013 /14 • Speeding up publication of CPI and RPI • Review of data collection methods for CPI and RPI • Review temporal coverage of CPI and RPI

35. National Statistics Assessment • Published in December 2010 • Made five recommendations • Develop greater understanding of use made of the statistics • Publish information about timeliness of statistics • Publish information on history and reasons for differences between CPI and RPI • Ensure new website improves accessibility of information • Ensure releases are issued at 9.30am • To be implemented by May 2011

36. Also some suggestions • Some about the range of outputs • Regional price indices • Indices for range of different household types • Possibly an index of perceptions of inflation • Some for more analysis and explanation • To explain uses and potential uses • Of strengths and weaknesses of CPI and RPI as macroeconomic measures and as compensation indices • Explain differences between price index and cost of living index

37. Other suggestions • Some about presentation of information • Further improve statistical bulletin • Additional commentary on external developments • Drawing attention to significant information in latest figures • Include clear explanation when differences between CPI and RPI is significant

38. 7. Consultation

39. Consultation • Number of different channels: • As part of wider consultation • Recent ONS wide consultation • Formal consultation: • Mortgage interest payments • Seasonal items • Via Statistical Bulletin • Review of changes to Bulletin • Via regular contact with users

40. Contact us • By email: cpi@ons.gov.uk • By telephone: 01633 456900 • On Twitter: www.twitter.com/statisticsONS • Our website: www.statistics.gov.uk